When an AA+ Is Not a Great Grade

The United States would not call an AA+ a great grade.

While a Fitch grade of AAA or even BBB usually mean not to worry about the borrower’s ability to repay a loan, grades at BB and below say you might not get your money back. (The other two major ratings agencies–S&P Global and Moody’s–have a similar ratings scale.)

The U.S. debt is still in high investment grade territory. Just one notch below the top, the new grade indicates the U.S. will meet its financial commitments. However, the 2023 debt ceiling “standoff” and soaring debt made the U.S. a less perfect borrower.

U.S. Debt Downgrade

Ratings

Downgraded by Fitch, to what FT called a “humdrum” rating, the U.S. now shares its spot with New Zealand and Austria, Meanwhile, it ranks below Luxembourg, Denmark, and Canada. You can see that the new AA+ rating is close to the top:

When a loan’s rating drops, then its price–its interest rate–goes up. Why? Typically, remaining constant, an interest payment is determined when a bond is issued. As a result (oversimplifying), when the price of the bond goes down because of less demand, the return–the interest rate–goes up. For some investors, the higher return makes the risk acceptable.

Debt to GDP Ratios

Fitch also would be worried about the U.S. debt to GDP ratio. Comparing the size of the debt to a country’s economic activity, the US debt to GDP ratio is soaring to wartime heights:

We can also compare different nations’ debt to GDP ratio:

Our Bottom Line: Credit Rating Primer

A credit rating grade sends a message. It tells investors what to expect when they buy a bond. Because a bond is a loan to a country, buyers want to know the likelihood of being paid back in full and on time. The credit rating is the standardized signal that tells them what to expect. It is an opinion about the risk of loaning a country some money.

Through their credit worthiness ratings, the major agencies help governments (and states, cities, towns, government agencies, corporations, and other entities) raise money by telling investors what they need to know. Essentially, bonds fall into an investment grade or speculative bucket. Certain financial institutions and municipalities would be limited to investment grade purchases.

Below, you could think of the U.S. as an issuer while the investor might be you or me. The intermediaries, like investment banks, connect issuers to investors:

My sources and more: After the downgrade, the coverage multiplied. The media included FT, WSJ and Reuters  At the same time, you might want (as did I) to see a firsthand explanation of the grades.