Fitch Ratings’ downgrade of U.S. government debt is much ado about nothing.
That’s not because the U.S. government’s credit worthiness isn’t important. But the financial markets already knew everything Fitch had to say about the state of the U.S. government’s finances. And the markets, efficient as they are, largely react only to new information.
You’ll therefore be hard pressed to find any price movement that you can confidently attribute to the downgrade. That hasn’t stopped analysts from searching the historical record for what happened following past downgrades or threatened downgrades, hoping to make predictions about how the markets will react this time around. They are searching in vain.
The hallmark of market efficiency is that any price action subsequent to an already discounted event will be random. Take the 10-year Treasury yield
BX:TMUBMUSD10Y,
which you might expect to jump following a downgrade. In the immediate wake of the August 2011 U.S. government debt downgrade, for instance, the 10-year yield fell. This time around it rose. Go figure.
Or take gold
GC00,
the geopolitical hedge you’d expect to rise in the wake of a U.S. government debt-rating downgrade. That is what happened immediately after the August 2011 downgrade. But this time, gold prices fell.
You might object that Fitch’s downgrade was genuinely unexpected and therefore is new information that should cause the markets to move. Except what’s important for the markets is not Fitch’s rating per se but the reasons the agency gave for its downgrade. And everyone already knew that those reasons were entirely true. There was nothing new for the markets to react to.
To quote directly from the Fitch report, U.S. government debt was downgraded because of:
- “A steady deterioration in standards of governance over the last 20 years, including on fiscal and debt matters…”
- “Eroded confidence in fiscal management…”
- [The absence of] a medium-term fiscal framework… [coupled with] a complex budgeting process.”
- “Only limited progress [has been made] in tackling medium-term challenges related to rising social security and Medicare costs due to an aging population.”
- “Over the next decade, higher interest rates and the rising debt stock will increase the interest service burden, while an aging population and rising healthcare costs will raise spending on the elderly…”
Anyone who found these observations to be news hasn’t been paying attention.
A fun armchair exercise is to imagine what government financing news would be momentous enough to significantly impact the market. One might be the announcement of a bipartisan compromise that solves the Social Security actuarial deficit. Another could be China announcing that it will dump its massive holdings of U.S. Treasurys. The list goes on.
In the meantime, let’s agree that the entirely unobjectionable and widely recognized truths in Fitch’s downgrade report are not enough to have any significant market impact.
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at [email protected]
More: What Fitch’s U.S. credit downgrade means for investors
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