Standard & Poor's on Monday downgraded its credit outlook for the United States, citing a risk that policymakers may not reach agreement on a plan to slash the huge federal budget deficit.
While the credit rating agency maintained the country's top AAA credit rating, it said authorities have not made clear how they will tackle long-term fiscal pressures.
S&P said the move signals at least a one-in-three chance that it could cut its long-term rating on the United States within two years.
Because the U.S. has, relative to its AAA peers, what we consider to be very large budget deficits and rising government indebtedness, and the path to addressing these is not clear to us, we have revised our outlook on the long-term rating to negative from stable, S&P said in a release.
The move will ratchet up the pressure on the Obama administration and Congress to come up with an aggressive long-term plan to chop a nearly $1.5 trillion deficit, equal to about 9.8 percent of output. It could push up U.S. borrowing costs and put further pressure on the dollar and the government's ability to finance the budget shortfall.
A downgrade to the U.S. AAA credit rating would also cause a spike in mortgage rates and tighten credit conditions across the economy. That would likely derail the economy's recovery from the worst recession since World War II.
The U.S. debt situation got a reality check this morning from the move by S&P, said John Kilduff, partner at Again Capital in New York. Only precious metals will be seen as attractive in the aftermath of the outlook downgrade.
Despite the potential implications of the S&P announcement, longer-dated U.S. government bond prices fell modestly, while major U.S. stock indexes showed a sharper reaction, shedding more than 1 percent in early trade.
Outstanding public U.S. debt has swelled to more than 60 percent of total output in the aftermath of the 2007-2009 financial crisis. With a budget deficit running at nearly 10 percent of output and expected to grow, the total is expected to swell further.
The Obama administration last week announced plans to trim $4 trillion from the budget deficit over the next 12 years, mostly through spending cuts and tax hikes on the rich.
A top administration official reiterated U.S. commitment to act on Monday and said S&P underestimated that resolve.
We believe S&P's negative outlook underestimates the ability of America's leaders to come together to address the difficult fiscal challenges facing the nation, said Mary Miller, assistant Treasury secretary for financial markets.
The U.S. dollar managed to hold gains against the euro on Monday, and traders said debt problems in some European countries were lending some support to the U.S. currency.
Even so, the greenback fell about 5 percent against major currencies this year, and record low interest rates together with the S&P move will do little to make it more attractive, said Kathy Lien, director of research at GFT Forex.
Even though I don't think an actual downgrade would occur, in this very sensitive or vulnerable time for the U.S. dollar, it's enough to spook investors from holding or buying U.S. dollars, she aid.
(Editing by Frank McGurty)