Will the US debt "gray rhinoceros" finally come? The latest research is here

Earlier this month, Fitch Credit Rating downgraded the U.S. long-term foreign currency issuer default rating from AAA to AA+, and revised its "negative rating watch" to "stable outlook." This is the second time the U.S. national credit rating has been downgraded following Standard & Poor's downgrading its long-term sovereign credit rating from the highest AAA to AA+ on August 5, 2011.

In the report, Fitch listed a number of key drivers affecting U.S. ratings: erosion of governance, soaring government deficits, rising broad government debt, unresolved medium-term fiscal challenges, recession in the economy, and tightening by the Federal Reserve.

Fitch also noted that several structural strengths underpin U.S. sovereign credit ratings, including a large, developed, diversified, high-income economy supported by a dynamic business environment. Crucially, the U.S. dollar is the world's leading reserve currency, which provides the U.S. government with a high degree of financing flexibility.

U.S. Treasury Secretary Janet Yellen immediately issued a statement strongly opposing Fitch's decision and saying that the adjustment was arbitrary and based on outdated data.

What is the impact of the U.S. economy and financial markets?

Jiang Fei, chief macro analyst of Great Wall Securities, believes that the continued positive fiscal expansion in the United States has supported the resilience of the US economy and maintained a high interest rate environment, but sacrificed the financial health of the United States. Fitch's downgrade of the U.S. rating is a sign of that sacrifice. He expects U.S. Treasury yields to continue to rise in the short term and the long-term impact to wane.

After the U.S. rating was downgraded by Fitch, the 10-year and 30-year Treasury yields stood at 4%. How will the downgrade affect the trend of US bonds in the medium and long term? And how will it affect the U.S. economy and financial markets?

Zhu Chaoping, global market strategist at JPMorgan Asset Management, believes that the recent rise in U.S. Treasury yields is mainly the result of short-term supply increases, and the rating downgrade affects market sentiment, but is not a decisive factor. Even in the face of a downgrade, U.S. Treasuries are still considered risk-free assets, and financial institutions are not under pressure to adjust their holdings, so the short-term sell-off risk is limited.

At the same time, the Fed will not change its policy path, and this rating downgrade will not have a material impact on economic fundamentals. In the medium to long term, international investors are likely to seek further diversification and increase their holdings of other highly-rated sovereign bonds as a result of the downgrade, especially after the Fed enters a rate cut cycle. This could lead to a decline in the dollar's share of international reserve currencies, affecting the U.S. government's long-term debt costs.

Wang Yi, head of quantitative investment at CSOP, also believes that U.S. bond returns are mainly on supply and demand issues, rather than actual ratings. At the same time, he pointed out that it is undeniable that if the US bond rate continues to rise, it will have a negative impact on the stock market.

Wang Xinjie, chief investment strategist of Standard Chartered China's wealth management department, said that the downgrade of US sovereign bonds by S&P last time, coupled with the US debt ceiling dispute at that time, had a direct impact on the stock market. Although the downgrade of the US sovereign bond rating also formed an impact on the stock market, the reason is more because the valuation of US stocks reflects more expectations of future interest rate cuts in advance, and also takes advantage of this event to digest the high valuation.

Wang Xinjie also pointed out that historically, gold's performance is favorable to short-term risk events, but there is no obvious reaction from gold this time, mainly because gold has priced in advance the expectation of future interest rate cuts. As a safe-haven currency, the US dollar did not perform well in the affected events in the United States itself, and Standard Chartered adjusted its view of the US dollar to be slightly negative in the short term, and still maintained its view on the medium- and long-term downward trend of the US dollar.

Fu Bejia, fund manager of HSBC Jinxin Shanghai-Hong Kong-Shenzhen Fund and Hong Kong Stock Connect Dual-Core Fund, believes that the downgrade and the US bond yield have risen again, which is expected to increase the pressure on financial liquidity in the US financial market in the short term, and it is necessary to beware of the possibility of local risks in the short term. The core influencing factor of the US economy is still the balance between inflation and growth, which is mainly driven endogenously, and the rating downgrade event itself has limited economic impact.

Will the US "twin deficits" continue for a long time?

Despite Morgan Stanley Wealth Management's Chief Investment Officer Lisa? Lisa Shalett believes that Fitch's downgrade could expose future U.S. government spending and debt proposals to greater scrutiny. However, representatives of the interviewed institutions almost unanimously expect that the "twin deficits" of US fiscal and trade will continue for a long time.

"Since 2002, the United States has been in a double fiscal and trade deficit, and it may be very difficult to reverse this situation," Jiang said. We believe that it is difficult to turn to active fiscal policy in the United States, especially as the United States faces the presidential election in 2024, and the Biden administration will continue to expand its fiscal capacity to maintain economic resilience. ”

Zhu Chaoping also believes that the US fiscal deficit may continue to accumulate in the future, mainly due to rising debt interest rates, increased spending on welfare such as education and medical care, and rising spending on climate change. In terms of trade deficit, the dollar's international reserve status itself means that foreign trade must continue to be in deficit The "Triffin problem", so the "twin deficit" of the United States will continue.

Zhu Chaoping also pointed out that scientific and technological innovation plays a decisive role in the trend of the US economy and dollar assets. If the United States can maintain its leading position in the field of science and technology, overseas capital will continue to flow in, supporting the US economy and dollar assets, and when the leading position of technology is shaken, the pressure of "double deficit" will appear, which may cause the depreciation of the dollar and the decline of dollar assets.

Lu Li, fund manager of Bosera Fund (International) Co., Ltd., also believes that in the medium and long term, the "double deficit" may increase the pressure on US interest payments and affect the sustainable growth of the economy, thereby weakening the US dollar and US stocks and falling US bond interest rates.

Will the US debt "gray rhinoceros" finally come?

If the US continues to expand its government deficit, will the US debt "gray rhino" one day come?

In this regard, Lurie pointed out that although US debt is regarded as a global safe asset, the continued accumulation of debt may gradually weaken investors' confidence in US debt and push up the level of US bond interest. Once the tipping point is reached and there are major risk events that the market does not expect, the fermentation of the "gray rhino" of US bonds may accelerate.

Jiang Fei also said: "No country can rely on borrowing money endlessly. But he also pointed out that in the current international economic system, countries face similar debt problems. Japan's macro leverage ratio, which is inferior to the United States, is significantly higher than that of the United States, interest rates are also at a low level, and the debt "gray rhinoceros" has not appeared. The United States continues to lead global economic growth through its liberal economic system and global talent attraction. So this foundation is not broken, and the problem of US debt is an embarrassing problem that the people of the world have to face.

Fu Beijia believes that the trigger core of the "gray rhinoceros" scenario is not the absolute deficit level, but whether the status of the US dollar reserve currency is shaken and whether medium-term scientific and technological progress can effectively drive economic growth and spontaneously reduce leverage.

Zhu Chaoping also believes that the arrival of the "gray rhino" depends on when overseas investors change their preference for dollar assets, which is related to the development prospects of US technology and economy.

Wang Xinjie said that U.S. bonds are still an important foreign exchange reserve of global central banks. This is actually a global financial system built with the US dollar as the main liquid currency, and from the micro level, "de-dollarization" is happening in different scenarios, but it is still far from finding a new system to replace the status of the dollar.

Wang Yi believes that if the gray rhinoceros represents the risk of default on US bonds, then this possibility is almost zero. There is no theoretical possibility of default on sovereign local currency debt, but the US government does have a debt ceiling constraint mechanism in debt management that other countries do not have, which is also the concern of rating agencies about the risk of US debt governance.

This article is from China Fund News