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A Debt Ceiling Deal May Not Stop a Fitch Downgrade – Money Morning

This is a syndicated repost courtesy of Money Morning. To view original, click here. Reposted with permission.

While the markets heaved a sigh of relief today (Wednesday) over a last-minute debt ceiling deal to avert a U.S. default, the threat of a downgrade from Fitch Ratings has not gone away.

Late Tuesday Fitch warned that it would downgrade its U.S. credit rating to “RD,” or restricted default, if Congress failed to come up with a debt ceiling deal before the deadline of midnight tonight.

But Fitch added that just any deal isn’t going to cut it.

In its press release, the credit rating agency said that the “manner and duration of the agreement and the perceived risk of a similar episode occurring in the future” would also factor into its decision to downgrade its AAA rating on U.S. debt.

In other words, if the debt ceiling deal resolves little except postponing the problem for another few months, Fitch will seriously consider downgrading the United States anyway.

The debt ceiling deal on the table right now would provide enough funds to end the government shutdown until Jan. 15 while extending the debt limit to Feb. 7 – less than four months away.

That might not be good enough for Fitch.

Fitch says it has had enough of the chaotic approach to budget issues in Washington, which has been the norm for several years now.

Among the factors Fitch said it would consider going forward is “the impact of the debt ceiling brinkmanship and government shutdown on our assessment of the effectiveness of government and political institutions, the coherence and credibility of economic policy, the potential long-term impact on the U.S. sovereign’s cost of funding and cost of capital for the economy as a whole, and the implications for long-term growth.”

Fitch added that debt ceiling deal negotiations in Washington risk undermining the confidence in the U.S. dollar as the global reserve currency by casting doubt over the full faith and credit of the United States.

“This ‘faith’ is a key reason why the U.S. ‘AAA’ rating can tolerate a substantially higher level of public debt than other ‘AAA’ sovereigns,” wrote Fitch.

Translation: Don’t be surprised if the net result of a lame debt ceiling deal is a Fitch downgrade within the next couple of weeks.

So what kind of impact might a Fitch downgrade have on the U.S. credit markets, or, for that matter, stocks and other investments?

For answers to these questions, we turn to Money Morning Chief Investment Strategist Keith Fitz-Gerald…

What the Fitch Downgrade over the Debt Ceiling Deal Would Mean

Any downgrade by a credit rating agency like Fitch would have an immediate negative short-term impact on the markets, Fitz-Gerald said Wednesday afternoon as Congress deliberated over the merits of the latest debt ceiling deal.

But he’s not worried about short-term impacts and says investors shouldn’t, either. What matters is what happens in the long term.

“Long term, their downgrade will lead to the U.S. dollar strengthening,” Fitz-Gerald said.

While that may seem counterintuitive, it makes sense if you think about it.

“The reason is the U.S. government and the Federal Reserve is going to want to earn that AAA rating back,” he said. “They’re going to do all they can to stabilize things.”

In fact, this is exactly what happened the last time Congress went to the brink over raising the debt ceiling in the summer of 2011 when Standard & Poor’s downgraded the United States from AAA to AA+.

Back then, Fitz-Gerald was one of the very few to predict that in the long run, the S&P downgrade would be good for the dollar and U.S. credit.

Sure enough, interest rates on Treasuries dropped in the months following the S&P downgrade. That should bode well for U.S. stocks and other dollar-denominated investments.

“Barring a default, they will enjoy the ride,” Fitz-Gerald said.

He cautioned, however, that Fitch and its fellow credit rating agencies have historically not exactly been ahead of the curve in fulfilling their duty of warning investors of looming credit risk.

“That they’re basing their decision on the quality of the debt ceiling deal is an exercise in irony,” Fitz-Gerald said, pointing out that Fitch, along with the other major agencies, failed to warn of the dire credit problems that led to the 2008 financial crisis. “Their track record on evaluating credit quality stinks.”

Nevertheless, yesterday’s warning matters to investors, he said.

“We need to pay attention because this means that the cost of the debt is becoming so big, even they can’t ignore it,” Fitz-Gerald said.

Note: While the debt ceiling deal should settle Washington’s budget issues – at least for a few months – the next big government headache is already under way. That would be the launch of Obamacare. The technical problems with the web sites are so deep and so severe that they alone could destroy the healthcare law…

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