Gold continues to enjoy gains this week after Asian stocks and treasury yields suffered significant declines following the U.S. credit downgrading from Fitch. After this rating, the U.S. lost its triple-A status, leaving many to question the economy’s stability. With economic questions come high safe-haven buying, hence the rise in gold prices.
Immediately following the release, spot gold increased by 0.3% to $1,949.29 per ounce, while gold futures rose by an impressive 0.4% to $1,986.30 per ounce.
After Tuesday’s Wall Street close, Fitch downgraded the nation’s credit rating from AAA to AA+. The primary reasons behind the credit rating drop were fiscal deterioration and the increasing governmental debt burden. After the debt ceiling debate nearly crumbled the economy just weeks ago, this news did not come as a large surprise to many.
The U.S. government’s gap between its income and spending continues to widen each year. As of August 1 this year, the U.S. government owed $32.6 trillion after fighting COVID-19, numerous wars, financial crises, and more. Now, the government has lost its status as carrying the highest rating, with Fitch noting the “erosion of governance,” particularly in the efforts to prevent the recent debt ceiling increase, as a primary cause.
The last time this happened was in 2011, when one of Fitch’s competitors, Standard & Poor’s, decreased the government’s rankings to AA+, though Fitch only issued a warning.
“Last time S&P downgraded in 2011, the markets went nuts, although we are not seeing the same type of reaction in the early going, but things bear watching,” Edward Meir, a metals analyst and researcher for Marex, explained.
While the previous downgrade may not have caused long-lasting impacts, the situation was much different. Fitch did not go through with the downgrade until now.
Moving forward, the United States may seem riskier now to lenders, which can cause large ramifications in terms of interest rates. Ultimately, we may be looking at a higher risk of the U.S. defaulting on its debts at some point in the future.
“Repeated debt-limit political standoffs and last-minute resolutions have eroded confidence in fiscal management,” Fitch explained in an announcement.
Janet Yellen, Secretary of the Treasury, disagreed with Fitch, explaining in a statement that the decision was “arbitrary and based on outdated data.” She continued to explain that the report used data points that “have shown improvement over the course of this Administration,” referencing the bipartisan legislation surrounding the debt limit.
“The American economy is fundamentally strong,” Yellen stated.
The government has a few options moving forward, though none seem too great. First, it could borrow more funds, which would only dig the debt hole deeper, causing higher risks of a default and a recession. Second, the government could increase taxes or cut spending, though both options come with numerous political risks and red tape that make the processes extraordinarily complex.
In general, high government debt typically goes hand-in-hand with poor economic growth. The downgrade from Fitch will likely only worsen this scenario, which at least means good news for gold prices.
Gold excels during poor economic periods as investors flock toward safe-haven assets to secure their funds while other commodities lose value. Between July’s disappointing job figures and the credit downgrade, the state of the economy is relatively clear. The odds of a soft landing following the end of the Fed’s credit tightening cycle are becoming less and less likely, meaning gold is becoming more appealing to investors as interest rates settle.
Federal Reserve committee members hope to settle inflation rates without fully curbing the job market, though July’s figures say otherwise. The Federal Reserve may choose to keep rates high in the mean team or conclude the cycle with one final hike in September; however, it’s still too soon to tell. High rates increase the opportunity costs of holding non-yielding assets, like gold, though as we near the end of the cycle, the precious metal has gained more traction.
How the Federal Reserve will respond to all of the incoming data is still highly up for debate. Fed Chairman Jerome Powell revealed that the door is still open for another hike; the committee plans to assess the economy over the coming weeks, then decide accordingly. Current marketplace estimates are showing a one in three chance of an interest rate hike in September, with a pause being the favored outcome.
As always, investors should consult their financial advisors before making any portfolio decisions.