Pristine AAA Bond Universe Just Got a Whole Lot Smaller

Sujata Rao and Denitsa Tsekova
·3 min read

(Bloomberg) -- The pristine universe of triple-A rated countries got a whole lot smaller this week after the US was stripped of its top-tier rating.

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It’s the latest example of a decade-long trend in developed economies as worries about high and rising debt burdens come to the fore. After Fitch Ratings cut the US to AA+, the firm said its ranks of AAA rated nations are down to 9, making up just 6% of government debt globally — from 41% before.

To be clear, there’s nothing particularly new about Fitch’s downgrade. Brinkmanship over America’s borrowing authority, aka the debt ceiling, has turned into something of an embarrassing hallmark of US politics. And demand for Treasuries, the world’s de facto risk-free asset and global benchmark for borrowing costs, is unlikely to vanish despite ballooning US deficits. (Then, there’s the whole other argument that ratings are largely irrelevant.)

What it does do is throw into sharp relief the steady deterioration of public finances in the biggest economies, especially as government spending swelled, first after the global financial crisis, and then during the pandemic.

“For too long, there’s been too much reliance on debt,” said Charlie Diebel, the head of fixed income at Mediolanum International Ltd. “There is a broader warning here over fiscal probity.”

The double-A group is now the biggest, accounting for about a half of the total government debt, according to Fitch.

Read more: Fitch Says Growing US Debt, Deficit Forecasts Spurred Cut

The Fitch’s downgrade comes more than a decade after S&P became the first ratings firm to strip the US of its AAA rating in 2011. (Moody’s, the third of three globally recognized ratings companies, still gives the US its top mark).

Downgrades of other formerly AAA rated countries over the decade has made ratings less relevant for investors, according to James Athey, investment director at Abrdn. What matters is that a country retains its place in the investment-grade bucket, he said, adding that, within that effectively, “AA becomes the new AAA.”

France was stripped of AAA in January 2012 by S&P Global, as the euro-area debt crisis raged and Fitch followed suit in 2013. The UK lost its top-tier rating from Moody’s in 2013, with Fitch downgrading it later the same year.

Fitch’s AAA club now consists of Germany and Australia, along with seven others, including smaller, rich countries such as Switzerland and Luxembourg. Back in 2011, Fitch rated 14 countries AAA.

Another measure of the triple-A universe — Bloomberg’s Global Aggregate Aaa Index, which includes both public and corporate bonds — will see its market value shrink by 70% after Fitch’s downgrade.

Treasury debt worth $10.4 trillion will be removed from the benchmark as of August 7, according to Bloomberg’s Index team, alongside $6.6 trillion worth of debt issued by US government-sponsored entities Fannie Mae, Freddie Mac and Ginnie Mae. It will leave the index with a market value of $7.4 trillion.

The loss of AAA status is even starker in the corporate world, with only Microsoft Corp. and Johnson & Johnson boasting those grades in the US, down from about 60 in 1980.

Globally, less 1% of the investment-grade credit universe is rated AAA, according to the Bloomberg Global Agg Corporate Index. In December 2005, about 7.4% of constituents had the highest grade.

Citi’s Zogheb Says AAA Companies May Benefit From US Downgrade

The question is what impact further downgrades might have. Since the 2010-2012 euro crisis, bond raters have zeroed-in on countries with big deficits, sluggish growth and unpredictable policies. But with interest rates pinned near zero at the time, those actions didn’t do much. That could change as debt bills balloon.

“Longer term, the deterioration in public finances in major countries could have a negative impact on growth, since debt service could crowd out other investment,” said Kathy Jones, Charles Schwab’s chief fixed-income strategist.

--With assistance from Alice Gledhill and Anchalee Worrachate.

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