Last night, Fitch (one of the three main credit rating agencies) downgraded the U.S. one-notch from AAA to AA+. Despite protests from the Treasury department and others, I think the downgrade is apt and a wake-up call to Washington. But, I don’t think it will negatively affect Treasury bond yields beyond a “knee-jerk” because U.S. Treasury bonds are virtually in a “rating-less” category as a world benchmark. Global investors need them regardless of their rating because of their liquidity, depth, and consistency. Because of the U.S. economy’s size and the dollar’s reserve currency status, Treasury yields will continue to reflect the outlook for the Fed, growth, and inflation. A comparison of the largest developed countries’ debt ratings below:

Japan has built up much more government debt than the U.S. (266% vs 119% debt-to-GDP ratio) and has been downgraded because of it. Japan’s two waves of significant credit downgrades in the last two decades are a useful comparison because Japan has a similar (but lesser) reserve currency status and are the world’s 3rd largest economy. Perhaps counterintuitively, as Japan was downgraded, 10-year Japanese government bond yields fell because the outlook for growth and inflation weakened in the wake of the 2001 and 2008 recessions. In other words, the downgrades didn’t cause a deviation from the standard bond dynamics of lower rates in recessions and higher rates with growth. It is hard to imagine that if more downgrades on more debt in a smaller economy than the U.S. didn’t cause higher yields, that it would in the U.S. now.