Fitch Downgrades and Partners Group - Breitling Deal

Welcome to the thirty-first Pari Passu newsletter,

Thank you for being part of our community.

Today, we will learn more about:

1. Fitch Downgrades & Precedents

2. Partners Group Investment in Breitling

Fitch Downgrades & Precedents

On August 1st, Fitch Ratings downgraded the U.S. long-term credit rating from its top mark of AAA to AA+, citing the nation's high and growing debt burden and the penchant for brinkmanship over America's authority to borrow money. With the last time US debt was notably downgraded by S&P in 2011, this reflects concerns over the nation's fiscal management and political handling of the debt ceiling. It also highlights the ongoing challenges and uncertainties surrounding the U.S. economic landscape. Today, we will deepen our understanding of how Fitch came to this conclusion, the history of the US debt’s downgrades, and what it means for investors.

Fitch’s Reasoning

Over the next three years, the U.S. government's financial situation is expected to worsen. This includes a high and growing debt burden, which has been a concern for the past two decades. The repeated political standoffs over the debt limit and last-minute resolutions have only added to the uncertainty. Fitch has observed a steady decline in governance standards over the last 20 years as well, especially concerning fiscal and debt matters. Even the recent bipartisan agreement to suspend the debt limit until 2025 hasn't eased these concerns. The complex budgeting process, lack of a medium-term fiscal framework, and successive debt increases due to economic shocks, tax cuts, and new spending have all contributed to this erosion. The limited progress in addressing long-term challenges like rising social security and Medicare costs for an aging population further complicates the situation.

The general government (GG) deficit is expected to rise to 6.3% of GDP in 2023, up from 3.7% in 2022 due to weaker federal revenues, new spending, and higher interest burdens. Even state and local governments are expected to run deficits, with the Fiscal Responsibility Act's cuts to non-defense spending offer only a small improvement, and Fitch doesn't expect any significant fiscal measures before the 2024 elections. Fitch also expects the GG deficit will continue to grow, reaching 6.6% of GDP in 2024 and 6.9% in 2025 driven by weak GDP growth, higher interest burdens, and wider state and local government deficits. The interest-to-revenue ratio, a key measure of fiscal health, is expected to reach 10% by 2025, significantly higher than the median for 'AA' and 'AAA' rated countries. Though the debt-to-GDP ratio has decreased from its pandemic high, it's still well above pre-pandemic levels at 112.9% this year and is projected to rise further to 118.4% by 2025. This ratio is over two-and-a-half times higher than the 'AAA' median, increasing the U.S.'s vulnerability to future economic shocks.

Imagine the U.S. government as a household that's been spending more than it's earning. Over the next decade, the interest on that debt is going to double, reaching 3.6% of the country's total income (GDP). At the same time, the population is aging, and healthcare costs are rising as the money set aside for social security and Medicare is projected to run out by 2033 and 2035, respectively. On top of that, tax cuts from 2017 might become permanent, which could mean even less money coming in.

Downgrade History

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