In the past few weeks, you might have come across headlines discussing the United States Treasuries rating being downgraded by Fitch, a US credit agency. In this article, we aim to provide you with a clear perspective on the credit downgrade and its potential impact on your financial journey, while also encouraging a sense of calm amidst the noise.
On August 1st, Fitch decided to adjust the US Treasuries rating from AAA to AA+. It’s important to understand that Fitch employs a scale ranging from AAA to BBB, with AA+ being a highly respectable second-place rating. This decision followed the resolution of the debt-ceiling standoff in June. Fitch’s rationale stems from the belief that a country delaying debt payments should not retain the highest rating. Additionally, Fitch anticipates the possibility of another debt-ceiling debate in the upcoming fall, which might lead to temporary government closures if consensus remains elusive.
A crucial distinction lies in the fact that this downgrade is tied to the government’s willingness, not its capacity, to service its debt in a timely manner. To put it simply, it’s like assessing a company’s balance sheet, where the debt-to-equity ratio indicates the proportion of debt in relation to assets.
As of the first quarter of 2023, the United States’ debt-to-equity ratio stands at around 0.82. This means that for every dollar’s worth of assets, there’s about 82 cents of debt. The key takeaway here is that the US holds the necessary assets to meet its debt obligations. Occasionally, differing opinions within Congress about budget allocation and spending priorities cause temporary disruptions.
While the accumulation of debt raises long-term concerns, think of it as like an individual who uses a credit card. As the balance grows, so do the payments, mainly due to the interest that accrues—an analogy akin to reverse compounding. While the national debt’s growth does increase the cost of servicing it, the reassuring aspect is that as long as the economy maintains a healthy pace, the short-term effects remain manageable.
In response to escalating debt, the government possesses the option to raise taxes to generate additional revenue. This becomes more plausible considering the historically low federal tax environment, which explains the recent enthusiasm for Roth accounts. This measured approach can help counterbalance the rising debt.
One recurring topic in news headlines revolves around the US defaulting on its debt, implying an inability to repay borrowed treasury notes. However, considering the nation’s steady economic growth, its stature as a global economic leader, consistent investing in in US debt (like treasuries), and the enduring strength of the US dollar, the likelihood of such a scenario remains exceedingly remote.
It’s important to recognize that while debt ratings carry weight, their significance is magnified for countries with emerging economies. These nations face challenges related to preferred currencies, trade relations, and interest rate autonomy.
While it might have been tempting to sensationalize the potential risk of a US debt default to attract attention, our perspective remains aligned with a steadfast investment philosophy: a balanced blend of long-term equity investments for sustained growth, coupled with safer assets like treasuries for immediate needs.
As you navigate through this news cycle, remember that steadiness and perspective are your allies. By focusing on your overarching financial strategy and aligning it with your goals, you’re empowered to approach this situation with confidence.
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* Government bonds and Treasury Bills are guaranteed by the U.S. government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value. However, the value of fund shares is not guaranteed and will fluctuate.
* Corporate bonds are considered higher risk than government bonds but normally offer a higher yield and are subject to market, interest rate and credit risk as well as additional risks based on the quality of issuer coupon rate, price, yield, maturity, and redemption features.
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* The Dow Jones Global ex-U.S. Index covers approximately 95% of the market capitalization of the 45 developed and emerging countries included in the Index.
* The 10-year Treasury Note represents debt owed by the United States Treasury to the public. Since the U.S. Government is seen as a risk-free borrower, investors use the 10-year Treasury Note as a benchmark for the long-term bond market.
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