Fitch Ratings' U.S. downgrade is the latest blow to dollar's global dominance, analyst warns

By Joseph Adinolfi

Fitch Ratings' decision late Tuesday to cut the U.S. government's credit rating represents the latest in a series of blows to the U.S. dollar's international standing and reputation, one financial markets economist told MarketWatch.

The ratings agency's criticisms could help countries like China and Russia to advance their efforts toward "de-dollarization," which would see the dollar's global dominance decline in favor of a multipolar order reliant on multiple currencies, cryptocurrencies or commodities, said Thierry Wizman, a financial markets economist at Maquarie Group.

Fitch's downgrade is the first by a major rating agency since Standard & Poor's ditched the U.S.'s AAA credit rating in 2011 after a previous fight in Congress about raising the federal debt ceiling. Although the U.S. dollar traded slightly higher on Wednesday, the decision represents an important messaging victory that could inspire more concrete action down the road, analysts said.

"There's clearly a movement afoot to try and replace the U.S. dollar among some countries in the world," said Thierry Wizman.

"If you're trying to displace the dollar, Fitch just gave you a little more ammunition. It's a public relations coup for these guys," he added.

After warning earlier this year that it was considering a cut during the latest debate in Congress about the debt ceiling, Fitch Ratings followed through late Tuesday by lowering the U.S.'s rating to AA+ from AAA. The agency cited "a steady deterioration in standards of governance over the last 20 years, including on fiscal and debt matters" as the justification for its decision.

See: Fitch slashes U.S. credit ratings to AA+ from AAA, points to 'erosion' of governance

Wizman wondered whether other factors, like the indictments against former President Donald Trump and other domestic political issues, might have also influenced the agency's decision.

"I do suspect that Fitch has in mind other things affecting governance, and one of them is the domestic political scene," Wizman told MarketWatch. "From a political stability perspective, it seems weird if your former president is indicted on a lot of charges, and he continues to be the front runner."

Fitch didn't respond to a request for comment from MarketWatch.

See: Trump indicted by special counsel over efforts to overturn 2020 election

De-dollarization has become a hot topic in economic and markets circles since Russia's invasion of Ukraine.

See:Big question with dollar under fire from rival countries and currencies: What happens to markets if the greenback loses its dominance?

Recently, China has succeeded in convincing more countries -- most recently Bolivia -- to commit to conducting more of their international trade using the Chinese yuan.

Meanwhile, Russia has reduced its U.S. dollar reserves in favor of gold and the yuan as U.S. and European sanctions have curtailed its banks' access to the global financial system. Leaders of other countries, including Brazil, have also said they would take steps to reduce their dependence on the greenback.

Russia, China and Brazil will soon have an opportunity to make their case at an upcoming summit for the so-called "BRICS" nations later this month in South Africa, Wizman said. South African President Cyril Ramaphosa has invited dozens of other nations as well, in addition to Russia, China, Brazil, India and South Africa, the original "BRICS" nations.

To be sure, many economists and currency strategists believe the U.S. dollar's status as the de facto global reserve currency remains secure for now.

However, this could change if the U.S. doesn't address some of the problems that Fitch touched upon in its announcement, one former Treasury official said.

"There's no worry about U.S. fiscal sustainability at this time," said Mark Sobel, a former top official at the Treasury Department for almost 40 years, during a phone interview with MarketWatch.

"But we do have some long-term issues. CBO figures show there's a huge surge [in borrowing] from 2030 on. That's something we need to be focused on as a society. And neither party seems to be willing to do that," he said.

Figures released by the Congressional Budget Office earlier this year projected the U.S. budget deficit will swell to roughly $2 trillion by 2033 compared to roughly $1.4 trillion in 2023.

See: Congressional Budget Office paints grim long-term U.S. deficit picture

For the time being, Sobel believes inertia and the lack of a single suitable challenger will help to protect the dollar's status. Any substitute or challenger to the greenback would also need to establish a track record of deeply liquid and accessible financial markets, free convertibility and the sanctity of the rule of law.

That could change, however, if the federal government fails to tame its borrowing over the long term, or if it oversteps in weaponizing the dollar's role in the financial system via sanctions.

There's a lot at stake both for the U.S. government and the American people: the U.S. dollar's reserve status helps to facilitate cheap imports, while suppressing the cost of borrowing, Sobel said. But there are drawbacks as well: a persistently strong currency can mean that manufacturing jobs gravitate toward countries where labor is less expensive.

Perhaps counterintuitively, the U.S. dollar has strengthened on Wednesday despite the downgrade. The ICE U.S. Dollar Index DXY, a gauge of the greenback's strength against major currencies, rose by 0.2% to 102.46 on Wednesday. The index has been weakening lately, and the buck is down 1% since the start of 2023, after rising more than 7% in 2022.

-Joseph Adinolfi

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08-03-23 0824ET

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