America's credit rating could get downgraded even if a default is avoided, Fitch Ratings warns

The US government plays a dangerous game of chicken over whether to raise the debt ceiling or default on US debt, which could cause America's credit rating to get downgraded.

America's credit rating could get downgraded even if a default is avoided, Fitch Ratings warns

CNN New York --

Every few years, Washington plays a dangerous game of chicken over whether to raise the debt ceiling or default on US debt. Even if a default is avoided this time, the frequent nature of these political showdowns could cause America's credit rating to get downgraded, Fitch Ratings told CNN on Monday.

'We are more concerned this time around,' James McCormack, Fitch's global head of sovereign ratings, said in an interview.

Fitch and Moody's give America a perfect credit rating, but this is not due to its fundamental financial situation. These are the reasons for the unprecedented credit ratings downgraded by S&P Global Ratings (2011). America's debt mountain and rising interest costs have only gotten worse since then.

The AAA rating is not based on fundamentals. It is based on America’s financial dominance. Investors view the US dollar as the global reserve currency, and US Treasuries as risk-free assets. These two attributes give the United States unparalleled financial power.

McCormack cautions, however, that repeated episodes like the ongoing debate about raising the $31.4 trillion debt limit will 'chip away' at these two issues.

Investors are faced with the impossible: a disastrous default on their debts. The closer the United States is to the X date of running out of money,

"When investors need to think about this, that's not what they're looking for when it comes to a risk-free asset. McCormack stated that investors should think about this and suggested that people might want to'reassess" whether Treasuries are truly risk-free.

According to a Bipartisan Policy Center analysis, the United States could default on its obligations in the summer or early fall if Congress fails to address the debt ceiling before then.

McCormack was asked if Fitch could downgrade America even if default is avoided at this point and McCormack replied that it would depend upon the reaction of global financial markets.

He stated that if the market reacts to the questioning of the role of the US dollar as the global reserve currency and the Treasury Market as the world’s risk-free asset, then we could absolutely do so.

McCormack stated that Fitch would be closely watching to see if other central banks stray from the US Dollar or US Treasuries.

This debate is made more dangerous by 'politized' politics

Washington is attempting to resolve the debt ceiling.

In January, Goldman Sachs stated to CNN that a full-blown crisis at the debt ceiling could lead to a recession. A default could cause chaos on Wall Street as well as Main Street, which could delay payments to Social Security recipients and military service members.

Thankfully, Fitch and many observers expect Washington will once again get its act together before that nightmare scenario plays out.

'We are of the view that this time will not be different and this will be resolved before the X-date,' McCormack said.

That's why Fitch does not have the United States on watch for a downgrade, at least not yet.

But McCormack conceded this debt ceiling standoff could be more dangerous given the situation in Washington.

'Political divisions look more intense. The US is more polarized,' he said.

Borrowing costs soar

The other issue is that America has continued to pile on debt – even as the cost of borrowing has surged. The Federal Reserve's inflation-fighting campaign has made it much more expensive to finance that mountain of debt.

Net interest payments on US government debt have doubled from $1 billion per day before the Covid-19 pandemic to $2 billion today, according to data from the Congressional Budget Office.

To put it another way: The United States spent about $500 billion over the past year on interest payments alone. That compares with the $2 trillion spent by all governments around the world on interest, according to Fitch. That means one out of every four dollars spent by government on interest is being paid by Uncle Sam.

Still, McCormack said the debt ceiling 'serves no useful purpose at all' from a fiscal perspective because it's not directly tied to the budget process. Lawmakers are merely debating whether or not to approve the borrowing of previously adopted budgets.

'You've already run up the bill, so it seems strange to have a debate later over paying it back,' McCormack said, adding that

Asked what advice he would give to lawmakers in Washington as they debate the debt ceiling, McCormack pointed out that ratings companies are forbidden by regulators from providing advice.

'But they are getting the right advice from the Fed and Treasury: You're playing with live ammunition here. This is an extremely dangerous situation. There is a lot at stake,' McCormack said.