Fitch Debt Downgrade Significance
On August 1, 2023 Fitch Ratings announced that it had downgraded its US debt rating from AAA to AA+. Across the board responses to this rating change have ranged from “I told you so” and “it’s about time” to “how dare you” and “that is crazy.” Fitch gave three reasons for their downgrade. These were an expected US fiscal deterioration over the next three years, the steadily growing US debt burden, and an “erosion of governance” when compared to nations with similarly high debt ratings. They specifically mention the fact that every time the US debt ceiling is addressed by Congress it turns into a circus and a potential crisis. So, what is the Fitch debt downgrade significance for options traders?
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Options Trading and the DRINC Acronym
At Top Gun Options we commonly refer to our DRINC acronym in regard to paying attention to events domestically and across that world. DRINC stands for Democrats, Russia, Iran, North Korea, and China. An example of how and when paying attention to events outside of the markets is important is the situation in China as the Covid-19 pandemic began. The US stock market was merrily going up on largely unfounded optimism about a trade deal with China Meanwhile China was shutting down whole cities in an attempt to stop the spread of a lethal virus. It was apparent to us that the economic impact of the virus would be catastrophic and the effects on the market huge. The Fitch debt downgrade is not going to have the same immediate effect on the market that Covid-19 did but, over time, the inability of the USA to come to terms with its addiction to living on credit will have devastating effects on the economy and the markets.
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Fitch Downgrade Was Not Something We Did Not Know
The Fitch debt downgrade did not come as a big surprise to most folks. Anyone who complained about it was probably more concerned about the optics of this announcement from a political point of view. Options traders need to be attentive over time to the factors that caused Fitch to downgrade US debt and not worry about the actual credit rating they are giving the US government. The steadily increasing US debt has been a problem for years. It is even worse this year and going forward as the US Federal Reserve raises interest rates to fight inflation. Suddenly the yearly cost of servicing the US debt has skyrocketed. It is the 6 thbiggest expense after Social Security, Health, Medicare, Income Security, and military spending. The problem going ahead is that as interest on the debt grows it will eventually require the country to cut back on other spending and that is where the political fights will occur again and again.
Picking Winners and Losers in the Coming Budget Wars
As a rule both major pollical parties want a strong national defense, especially in view of Russia’s aggressive military posture and China’s drive toward military dominance. Republicans routinely want to cut taxes and Democrats want to spend on social issues. Everyone agreed for years that the US was in dire need of a program to upgrade our national infrastructure but the cost of doing so has helped ramp up inflation and become a political issue in and of itself despite the fact that the infrastructure bill had bipartisan support. Investors and traders will need to keep a close eye on where money is being allocated as budget rage. If taxes go up that will slow the economy. If spending is curbed it will affect businesses in the affected sectors and their stock prices. As the Covid-19 crash hit the market we only needed to trade the S&P 500 as a reliable measure of the US economy. This worked both for the crash and the rebound. Over the longer term it is likely that this approach will be useful again. However, depending on how bad the budget crises get and who is in charge in Congress and the White House there may be specific sectors that will thrive or collapse depending on action by the federal government.
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Originally published at https://topgunoptions.com on August 6, 2023.
