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Debt ceiling: Market implications of U.S. credit downgrade

Yahoo Finance senior columnist Rick Newman discusses the implications of credit agency Fitch putting the U.S. AAA credit rating on watch.

Video transcript

- Well, the pressure to secure a debt limit deal is getting more urgent as credit rating agency, Fitch, puts US debt on rating watch negative. Yahoo Finance's Rick Newman is following that story, and Rick, a lot of people are saying, this feels like 2011 all over again, although the downgrade has not happened yet.

RICK NEWMAN: Right. And it's really worth going back to 2011 to figure out what might happen if there is a downgrade by Fitch or by Moody's or by any other rating agency. When this happened in 2011, it felt cataclysmic. Like, this was something that was never supposed to happen, and it might change everything about the way United States issues debt and the credit worthiness of the United States.

And that did not happen. In fact, something crazy happened in 2011, which is-- you would have expected when your credit rating goes down, almost all the time you have to pay more to borrow because you're considered to be a riskier bet. The opposite happened in 2011, which is that US Treasury rates actually went down, ironically, because the whole situation sent people out of risk assets, such as stocks and into what they considered safer assets.

And what did they consider to be the safest house that they could find? US treasuries-- the very asset that effectively had just gotten downgraded by Standard Poor's. So the United States has continued to enjoy the lowest borrowing costs in the world since then.

Now, they've gone up lately as overall interest rates have gone up, but given that we went through this once in 2011 and basically survived with hardly any damage, that could be what happens again if Fitch actually would go ahead and downgrade the US credit rating.

Now, Fitch has basically said, we're only going to do that if there is some sort of default scenario. And let's remember-- let's define default correctly. Default means very specifically not making interest payments on US debt.

John Lieber from Eurasia group was talking before about not making interest payments to-- excuse me. Or payments to vendors or things like that. That is technically not default, and that is not something that in theory would trigger a credit rating downgrade.

But you know, this-- again, this is all somewhat uncharted territory. We got a little bit of this in 2011. We could get further into it in 2023. Maybe we will really get into the mess in 25 or 27. Who knows?

- Rick, what do you think-- how do you think lawmakers are looking at this warning here from Fitch? Do you think it's adding some urgency to those talks? They should have already been pretty urgent, but do you think it's adding a little bit here just in terms of the pressure that they're facing as we do get closer and closer to that ex date?

RICK NEWMAN: Not really. So market-- I mean, a lot of analysts have been saying that the thing that will really get these jokers in Washington DC to get a deal done is when they start to see real turbulence in financial markets, and the Fitch warning on its own has not produced any kind of turbulence in financial markets. In fact, I think the markets are up today, and everybody is talking about NVIDIA-- and you know, amazing results in the private sector not about what's happening in Washington DC.

So I think as we get closer to the point at which the Treasury actually cannot make all of its payments, you will start to see more pronounced moves in financial markets. I should point out we are already seeing some elevated interest rates for short-term US debt. There is a bit of a risk premium there because those are the-- that's the debt that in theory might be at risk if there is some kind of default scenario.

But I think I'd have to get considerably worse than it is right now for Congress to really sit up and take notice, but the closer we get to that so-called X date, the more punchy everybody is going to get, including financial markets.

- Yeah, and just a reminder-- we are exactly a week out from June 1 and that X date. Rick Newman, as always, thanks so much for that.