By Tim Courtney, Chief Investment Officer
In recent months, the United States has experienced two rating downgrades. In August, Fitch Ratings downgraded our nation's debt from AAA to AA+1 followed by Moody's Investors Service adjusting its ratings outlook on the U.S. government from stable to negative last month.2 These investment ratings services join Standard and Poors in viewing U.S. debt less favorably, which changed its rating back in 2011.3
Spokespeople for the administration and Treasury responded to these recent changes as they did in 2011: by saying the change is wrong and U.S. debt is the highest quality debt in the world.4 The market will ultimately decide if these changes are warranted based on the interest rate at which lenders are willing to lend to the U.S. Interest rates for treasuries have been moving quite a bit recently. The 10-year treasury nearly reached 5% in October, the highest level since just before the Great Financial Crisis in 2007, before falling back down to 4.25% recently.5
The ratings companies are paid by investors to provide guidance on the stability and strength of borrowers. Assuming these companies did not wish to antagonize the U.S. and draw rebukes from government officials, it would appear they are seeing a valid reason to lessen their enthusiasm for U.S. debt.
U.S. spending levels and annual deficits are accelerating at a time when employment is full, and Gross Domestic Product (GDP) is growing. Unemployment is hovering at less than 4%6 while inflation sits above target at 3.2%7 and GDP climbed over 4% in the third quarter.8 For Keynesian economists who tend to dominate academia and government agencies, this level of growth would call for the government to spend less and lower deficits.9
Instead of easing off the pedal though, the government is punching it. It is taking a larger slice out of the economy, with federal spending increasing from 19% of GDP in 2007 to 25% of GDP today.10 The government is and has been growing faster than the economy, which has implications for future growth and future tax rates.
U.S. debt still retains high ratings, and it is extremely liquid with over $600 billion in treasuries traded every day.11 For most investors, having at least some exposure to treasuries in a portfolio either directly, in funds or in money markets probably makes sense. The U.S. economy still has many things working in its favor. But ratings agencies like Fitch and Moody's are monitoring trends and signaling that the status quo may not last indefinitely. Just as households find there is a limit to how much they can spend without painful consequences, the rating companies are signaling the nation is testing the limit on how much it can spend without consequences.
For now, we continue to recommend holding treasuries in most bond portfolios and are pleased that we can now earn higher interest on them. As taxpayers, we hope that the government starts listening to the ratings companies and that we don’t keep testing the limits of our spending.
If you have any questions, please feel free to contact your Exencial advisor.
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