INVESTING EXPLAINED: What you need to know about AAA credit rating

In this series, we bust the jargon and explain a popular investing term or theme. Here it’s AAA. 

What is this?

It is the highest possible type of credit rating. These closely watched scores aim to show the capacity of a company or a country to repay its debts – vital information for anyone who has lent money to that business, or has bought the bonds issued by that nation. Triple-A indicates ‘extremely strong capacity’ to repay borrowings. Ratings are calculated and awarded by credit agencies. The three best known are Fitch, Moody’s and Standard & Poors (S&P).

Why are we reading about it?

Last week, Fitch Ratings cut its rating for the US by one notch from triple-A to double A plus. The agency cited ‘expected fiscal deterioration over the next three years’, ‘a high and growing government debt burden’ – and an ‘erosion of governance’.

This follows the 11th hour agreement to raise America’s debt ceiling back in May.

For a while, it had seemed that the world’s largest economy would not be able to pay its bills, with a few Republicans arguing that the US should default on its debt, rather than increase the amount. This currently stands at $32.6 trillion and is made up of various types of government bonds or ‘Treasuries’ issued to raise money.

Stamp of approval: Triple-A indicates ‘extremely strong capacity’ to repay borrowings

What was the reaction to this downgrading ?

Janet Yellen, the US Treasury Secretary said Fitch’s decision was ‘arbitrary and based on outdated data’. Nevertheless, the downgrade sent out a message that the US, which has been seen as the safest of safe havens, was higher risk than before. Thus the news hit share prices in the US and elsewhere.

Any other response?

Some big US stock market players – the Tesla boss Elon Musk, the Berkshire Hathaway manager Warren Buffett and hedge fund billionaire Bill Ackman – shrugged off the downgrade. All three rushed out to buy short-dated Treasuries. But Ackman has also gone ‘short’ (betted against) 30-year Treasuries arguing that their prices do not reflect the expectation that inflation will remain higher for longer.

Why care about US credit ratings?

THE adage that ‘when America sneezes, the world catches a cold’ tends to hold true. Fitch’s decision hit share prices in the UK.

What are the UK’s ratings?

Fitch and S&P rate the UK as Double A – which is a notch below Double A plus. Fitch says that this reflects ‘a high-income, large, diversified and flexible economy, a credible macroeconomic policy framework, deep capital markets and sterling’s international reserve currency status’. But the UK has ‘high public and external debt’ and there is also ‘uncertainty’ over the relationship with the EU post-Brexit. Moody’s rates the UK as Aa3 – the number three ranking in its system in which Aa1 is the best rating.

Are some countries still triple-A?

Yes, but the number has reduced over the past decade thanks to the large amount of debt taken on by governments in the wake of the global financial crisis and during the pandemic. The triple-A nations are Australia, Denmark, Germany, Luxembourg, the Netherlands, Norway Singapore, Sweden and Switzerland. Together they represent just 6 per cent of the world’s government debt.

Johnson & Johnson and Microsoft are triple-A rated companies, but no FTSE 100 companies enjoy this status.

This post first appeared on Dailymail.co.uk