Will the credit rating agencies stand up to Donald Trump?

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The writer is the chief economist at German bank LBBW and former chief sovereign ratings officer at S&P

The US last year reached a critical point: the federal government had to spend more on interest payments than it did on defence. According to an economic pattern identified by the historian Niall Ferguson, hegemonic powers that spent more on interest than on the military in the past entered a period of geopolitical decline. Is this now the fate of the US?

The current disarray of American public finances makes us imagine the previously unimaginable: the issuer of the world’s foremost reserve currency being overburdened by public debt. This debt is on track to surpass 160 per cent of GDP by mid-century, according to estimates from the Congressional Budget Office. In the next 10 years, State Street says $2tn annually of net issuance of Treasury debt is expected. Unlike in the 2010s, the Federal Reserve and other price-insensitive buyers, such as foreign central banks, may not be net buyers. Some European sovereigns look similarly exposed. Governments seem to perennially believe that their economies are in a bad spot and need propping up through fiscal stimulus.

As the era of close-to-zero interest rates is fading into history, the debt service burden will inexorably rise. This will come on top of a secular deceleration of the world economy and thus tax receipts; higher public spending on ageing populations; and rising defence outlays. At the same time, political dysfunction is on the rise, rendering fiscal consolidation a remoter prospect.

Thankfully, there are institutions that warn investors of rising sovereign risk: the rating agencies. Or are there? It is fair to question whether the big three agencies — S&P Global, Moody’s and Fitch — have become more coy about the risks of rich countries. In contrast, the agencies seem more willing to dish out downgrades to emerging and developing economies.

This ratings bifurcation became glaringly obvious during the Covid-19 pandemic: the agencies downgraded poor countries left, right and centre, but left advanced economies’ ratings unscathed. Fitch has cut credit ratings on the US, France and the UK in recent years. Moody’s and S&P also downgraded France last year. But the trend is more about a divide.

Between 2000 and 2014, the Big Three rating changes for rich sovereigns were more negative than for emerging markets. The net change — upgrades minus downgrades — of advanced sovereign ratings was about 1 per cent of the rated portfolio per year, compared with an even higher net-upgrade ratio of 8 per cent for emerging markets.

But between 2015 and 2024, there have been even more upgrades for rich countries (a net balance of about 3 per cent of the portfolio per year), despite what appear to be weakening fundamentals. In sharp contrast, emerging markets saw a net balance of about 4 per cent of their sovereign portfolio downgraded, a huge swing from the buoyant earlier period. 

In the face of deteriorating public finances in Washington during the pandemic and 10 weeks after a violent mob stormed the Capitol. S&P raised its assessment score of the institutional strength of the US on its 1 to 5 range to its top level of 1. This step in effect averted a downgrade as its assessment of the US fiscal performance had deteriorated.

There is no question that many emerging sovereigns’ creditworthiness has taken a hit during the past decade. The net downgrade pattern seems appropriate. But has the forward-looking creditworthiness of the rich world really improved over the same period? That appears far-fetched. What seems more likely is that the agencies have taken fright after lawsuits and regulatory backlashes following the financial and Eurozone debt crisis.

For example, the S&P — the first agency to downgrade the US in 2011 — had been the subject of particular ire from policymakers on both sides of the Atlantic, from a costly Department of Justice lawsuit to criminal prosecution in Italy. Disclosure: I was part of the committee that downgraded the US and I was a defendant in the Italian case in which the agency and my colleagues were acquitted. My time at the S&P ended in 2018.

The prime role of credit agencies on sovereign debt is to call out credit risk without fear or favour. If not, some investors may be lulled into a false sense of security, which may allow governments to procrastinate and dig themselves into ever-deeper holes. One test might be looming. If US finances deteriorate further, are they prepared to stand up to President Donald Trump and cut ratings?