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When one of the largest credit agencies threatened to downgrade the U.S. government’s credit rating Wednesday, it underscored one of the ways the debt ceiling crisis can affect household budgets: influencing interest rates that everyone pays.
Fitch Ratings, one of the three most important credit agencies alongside Standard & Poors and Moody’s, put the U.S. government on notice Wednesday that it was considering downgrading its credit rating. The agency saw a growing possibility that the government will miss paying some of its obligations because of the debt ceiling crisis still dragging on, as negotiations between President Joe Biden and Congressional Republicans go down to the wire before the government runs out of money to pay its bills.
The creditworthiness of the U.S. government in the eyes of ratings agencies and investors is key because it directly affects how much interest the government pays on its debts, which in turn affects rates on all kinds of consumer loans including mortgages. Whether the debt ceiling crisis pushes borrowing costs down or makes them spike depends on how the standoff unfolds, and how markets react.
When credit agencies downgrade the debt of a company or bank, that signals to investors that the debt is riskier, and investors in turn demand higher interest rates to compensate them for the increased chance they won’t be paid back. The target of the downgrade typically must pay higher borrowing costs from then on.
Yet the U.S. government is no ordinary institution. U.S. Treasury securities are seen as a sure bet by investors and a one-tick downgrade from a single credit agency wouldn’t threaten that status, said Ryan Sweet, chief U.S. economist at Oxford Economics. Ironically, a credit downgrade would likely roil financial markets, raising demand for U.S. debt and pushing interest rates down.
“The U.S. is a safe haven asset,” Sweet said. “So money would still continue to flow into the US. What you see when you have these nasty debt ceiling fights is that when markets are pricing in Armageddon—the prospect of the U.S. defaulting—long term interest rates actually decline rather than rise.”
That’s exactly what happened in 2011 in a previous debt ceiling standoff when Standard & Poor’s downgraded the U.S. credit rating, causing yields on 10-year treasurys to fall.
While a single downgrade wouldn’t damage the country’s creditworthiness too much in the short run, Fitch’s warning highlights the dangers of worse consequences if negotiators fail to reach an agreement, and the U.S. actually misses payments. Treasury yields, mortgage rates, and other interest rates would spike in the event of a prolonged standoff with missed payments, economists at Moody’s Analytics said in an analysis in March.
“So many assets are priced in direct relation to U.S. Treasuries that the turbulence from a more pronounced downgrade would be felt in markets worldwide,” Nikolaj Schmidt, chief worldwide economist at T. Rowe Price said in a commentary earlier this month.
The crisis also could have longer-lasting effects, Tom Graff, head of investment at Facet Wealth said in an email.
"A downgrade from Fitch in and of itself probably isn't so important, but the rationale Fitch is using could be very important,” he said. “The more times we flirt with this debt ceiling, the more investors in U.S. Treasuries have to consider it as a risk. That will have some impact on U.S. interest rates even after this specific episode passes."