Wall Street starts fretting about US debt again after months of easy stock-market gains

In what has been an impressive year for the stock market so far, the benchmark S&P 500 index has maintained a remarkable five-month winning streak, boasting a 19% surge in 2023. This success has been attributed to an anticipated Federal Reserve pause and a remarkable surge in interest surrounding artificial intelligence.

The backdrop of this market boom has been a series of encouraging economic indicators, including second-quarter growth surpassing analysts’ projections, a notable cooling of inflation, and a steady unemployment rate holding at under 4%.

However, the recent surprising move by Fitch to slash the credit rating of the US government introduces a novel challenge for investors: confronting unfavorable news.

Following the announcement of the ratings agency’s decision late on Tuesday, stock prices experienced an initial slump in early-morning trading. The market managed to recover some of these losses before the opening bell. AJ Bell’s Head of Investment Analysis, Laith Khalaf, highlighted that Fitch’s downgrade “will naturally trouble investors and make them rethink their portfolio.” He noted, “It also might surprise some people given how the US economy is proving to be more resilient than expected.”

This marks the first such downgrade since 2011 when Standard & Poor’s took the unprecedented step of downgrading the US credit rating. In response, the S&P 500 suffered a 6.5% drop, taking six months to fully rebound.

While the immediate aftermath of Fitch’s announcement did not trigger such a drastic market response, earlier this year, the White House cautioned that a failure to meet debt obligations could lead to a staggering 45% plummet in stocks.

Fitch’s decision follows the US government reaching its $31.4 trillion borrowing limit in January, ultimately brokering a last-minute deal to raise the debt ceiling. The government is expected to borrow an additional $1 trillion in the third quarter alone.

The handling of this situation by Congress garnered criticism from financial experts, including hedge fund manager Ray Dalio, who likened the process to “a bunch of alcoholics who write laws to enforce drinking limits.” Fitch itself cited political deadlock in Washington, coupled with a “steady deterioration in standards of governance over the last 20 years,” as the driving forces behind the downgrade.

While the risk of an actual US default remains low for now, thanks to the suspension of the debt ceiling limit and the country’s still-strong AA+ rating—equivalent to Canada’s—Fitch’s downgrade serves as a stark reminder that investors may not continue to experience smooth sailing for the remainder of the year, following an exceptionally strong start to 2023.”