Fitch Ratings, one of the three major credit-rating agencies, announced on Tuesday that it has downgraded the U.S. long-term debt rating from AAA to AA+. This means that Fitch believes the U.S. government is less likely to repay its debts in full and on time, which could increase the borrowing costs for the U.S. and affect its economic stability.
Fitch cited several reasons for the downgrade, including the repeated political standoffs over raising the debt limit, the high and rising public debt burden, the erosion of governance standards, and the uncertain fiscal outlook amid the Covid-19 pandemic. Fitch also warned that further downgrades are possible if the U.S. fails to address its fiscal challenges and restore confidence in its creditworthiness.
The downgrade comes only two months after President Joe Biden and House Republicans reached a last-minute deal to suspend the debt ceiling until January 2025, avoiding a potential default that could have triggered a global financial crisis. The deal was signed on June 2, just three days before the U.S. Treasury said it could run out of money to pay its bills.
How markets reacted to the news?
The news of the downgrade did not seem to have a significant impact on the financial markets, as investors had already anticipated the possibility of a lower credit rating for the U.S. The U.S. stock futures pointed to a weaker open on Wednesday, but recovered some of their losses later in the day. The Dow Jones Industrial Average closed down 0.2%, while the S&P 500 and the Nasdaq Composite ended slightly higher.
The U.S. Treasury market also showed little reaction to the downgrade, as demand for U.S. government bonds remained strong. The yield on the 10-year Treasury note, which moves inversely to its price, fell slightly to 1.18% on Wednesday, near its lowest level since February. Investors still view U.S. Treasuries as a safe haven asset, especially amid the rising concerns over the Delta variant of Covid-19 and its impact on global growth.
The U.S. dollar, however, weakened against other major currencies after the downgrade, as investors worried about the implications of a lower credit rating for the world’s reserve currency. The dollar index, which measures the greenback’s value against a basket of six other currencies, fell 0.4% on Wednesday to 91.9, its lowest level since June.
Why gold may benefit from the downgrade?
One asset that may benefit from the downgrade is gold, which is often seen as a hedge against inflation, currency devaluation, and geopolitical risks. Gold prices rose 0.6% on Wednesday to $1,814 per ounce, as investors sought refuge in the precious metal amid the uncertainty over the U.S. debt situation and its global ramifications.
Gold has historically performed well during periods of lower U.S. credit ratings or debt ceiling crises. For instance, in 2011, when Standard & Poor’s downgraded the U.S. debt rating for the first time in history, gold prices surged to a record high of $1,921 per ounce in September of that year. Similarly, in 2013, when Fitch placed the U.S. debt rating on negative watch due to another debt ceiling impasse, gold prices rose 8% in October of that year.
According to some analysts, gold may have more room to rally in the coming months, as the downgrade could trigger more demand for gold from central banks and institutional investors who are looking for alternative assets to diversify their portfolios. Moreover, gold may also benefit from other supportive factors, such as low interest rates, high inflation expectations, and rising geopolitical tensions.