U.S. Long-term Foreign Currency Debt Rating Downgraded to AA+ by Fitch Ratings

AAF Wealth Management would like to make clients aware that Fitch Ratings announced a downgrade to its U.S. long-term foreign currency debt rating from AAA to AA+ over concerns with a growing U.S. budget deficit and an erosion of U.S. governance relative to comparably rated peers throughout the past two decades, which led to repeated debt limit standoffs and last-minute resolutions. This move is not unlike the August 2011 S&P downgrade.

U.S. currency remains one of the safest amid its peers. With entitlement spending far outpacing incoming tax receipts and balance of trade, a downgrade was only natural. Therefore, we view this move as symbolic, i.e., a natural response to dynamic political and economic conditions. That being said, it does have the potential to drive yields higher over time.

When taken in conjunction with the Bank of Japan’s yield curve control actions Monday night, which allows target bands for Japanese Government Bond (JGB) yields and interest rates to move higher, we do begin to see global shifts taking place. We mention this because the Japanese Yen plays a large role in global cash markets. In that light, it is worth noting that, for the first time in decades, JGB rates have pushed through the high end of the 25-basis-point upper band. Since then, yields have moved higher despite the bank’s ability to buy unlimited amounts of paper as needed. While the purchase should have brought yields down, this did not happen.

Japan has faced deflation for 30+ years and ultra-low interest rates have ensued, inviting foreign investors to borrow in Yen and redeploy those assets, called a carry trade, into higher yielding assets around the world. This trade played a significant role in what helped to drive U.S. markets upward from March 2009 through March 2020.

Over time, as speculators profit and pay their margin loans back against the Yen from which they borrowed, they close out what was effectively an interest-free loan. Investors can liken this to taking a cash-out refinance against their house at near zero percent interest rates and using those dollars to buy stocks. Eventually they would need to pay the loan back; in the interim, however, the cost was minimal to generate a profit via speculative pursuits.

What investors should know.

Neither move, whether the downgrade by Fitch or actions by the Bank of Japan, whether individually or collectively, will likely crash U.S. stocks in the short term. It will take time to see whether actions by the Bank of Japan or Fitch have a meaningful impact. AAF Wealth Management handles the research, trading, and maneuvering on our client’s behalf. We will continue to monitor matters closely, adjusting portfolios as necessary.

If you have questions, please contact Kevin P. Hodson, CMT, AIF® Wealth Advisor at 774.512.4173 or khodson@nullaafwealth.com—or your AAF Wealth Management advisor.

About the Author

Kevin is a Wealth Advisor at AAF Wealth Management, providing comprehensive solutions for family offices, high-net-worth individuals, as well as for-profit and not-for-profit organizations Kevin’s expertise strengthens each client’s financial situation by delivering a full range of solutions, identified based on need and uncovered through on-going consultative meetings and interactions. These solutions include personal financial planning, investment management, tax advisory, insurance, estate & philanthropic planning, and business succession planning.