COLUMN - Last week, the ratings agency Fitch downgraded US debt by one notch, from AAA to AA+. Fitch attributed the downgrade to the US government's overspending and polarized politics.
So, what does this mean?
Think of it in the context of applying for a loan – the bank looks at your credit score to determine the interest rate you pay. In America's case, their credit score has been lowered a bit, meaning it will be more expensive for them to borrow money.
The chart below illustrates this change.
If you look at the right-hand side (red arrow pointing up), you see the yield on the US 10-year bond jumping from 3.7% to 4.2% at the time of the downgrade.
The yield in this case is the rate the US pays its lenders (like the rate you pay the bank when you borrow money). It increases when perceived risk goes up.
Interestingly, the result of the US debt downgrade was a flood of money coming back into the US.
This is because when any sort of uncertainty transpires in the world (even when it is about the US), investors tend to move away from riskier assets (like emerging market currencies and equity markets) and back into perceived safety (the US). We’ve seen this trend play out time and time again.
Let’s look at what happened to the rand.
The rand was trading at R17.27 when the news came out, and as of writing, it is R18.71. That's an 8.7% weakening in just a couple of days(!)
And just when things were looking up – load shedding reduced from stage 8 to stage 4 with growing evidence that further capacity will be added to the grid, Russia's President Vladimir Putin being disinvited to this month's BRICS summit, and the US Trade and Development Agency awarding Eskom with a grant to fund technical assistance.
These latter developments suggest the relationship between the US and SA is on the path to being mended.
The news also had an impact on the JSE, which dropped almost 3% on the day.
Now, should we be worried?
Based on reactions from people like Larry Summers (former US Secretary of the Treasury) and Janet Yellen (effectively the US Minister of Finance), this downgrade won’t lead to any major policy changes by the US, and markets will likely absorb it. The US government is still considered highly credible, and nobody expects them to default on their debt.
As a result, the rand will likely start strengthening again and the JSE market begin a slow recovery.
I want to leave you with two charts –
- the debt to GDP level of the US (essentially what caused the credit downgrading)
- and the debt to GDP level of South Africa.
Who do you think is more indebted? The answer may surprise you.
Chart: United States Gross Federal Debt to GDP
Chart: South Africa Government Debt to GDP
Matthew Matthee has a wealth management business that specialises in retirement planning and investments. He writes about financial markets, investments, and investor psychology. He holds a Masters Degree in Economics from Stellenbosch University and a Post Graduate Diploma in Financial Planning from UFS. MatthewM@gravitonwm.com
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