US Faces a Downgrade

In 2011, the United States emerged from a Congressional budget battle with a downgrade of it AAA rating for the 1st time in history.

In 2013, it could see a larger downgrade. The battle over avoiding the Fiscal Cliff is the 1st of a series of partisan confrontations in Washington in the coming year that, sans timely resolved, could cause more downgrades of the US credit rating.

“The rating is in the hands of policymakers,” said John Chambers, chairman of Standard & Poor’s sovereign rating committee, the agency that downgraded the United States in August 2011.

In interviews with Reuters recently, the 3 major rating agencies said cutting the US debt rating is highly likely if next year’s budget process replays 2011′s debt ceiling debacle or if the seemingly simple goal of cutting deficits goes unmet.

Should that happen, it could have a damaging effect on the country’s cost of borrowing and could also shift some investment away from the United States, though the country’s big markets and attractiveness as a safe haven are likely to limit those effects.

In the absence of a sustainable, coherent medium-term vision for the US federal budget, which has produced deficits above $1-T in each of the last 4 yrs, the rating will fall. The Fiscal Cliff is a step in that process, but the possibility of a downgrade will still loom over Washington throughout the year.

“If no budget deal is reached in the early part of next year and the debt trajectory just continues to rise … then we’d be looking at a downgrade of a notch to Aa1,” said Bart Oosterveld, managing director at Moody’s sovereign risk group.

Automatic spending cuts in January coupled with significant tax increases could take an estimated $600-B out of the US economy and push it into recession, according to the non-partisan Congressional Budget Office’s assessment of the fiscal cliff.

The effects will be gradual, but significant, with the unemployment rate possibly rising to 9% or higher.

If Congress goes over the Cliff, Moody’s said it will watch how the economy deals with the abrupt shock and will maintain the current negative outlook it holds on the United States.

Ultimately, if Congress and the President cannot reach a deal to stabilize and eventually reduce the debt, now at $16-T, Moody’s will probably cut the United States’ current Aaa rating.

Fitch, meanwhile, said even a deal to avert the Cliff might not be enough to save the nations Aaa rating.

Temporary measures to stave off the budget shock without a credible strategy for the years beyond could earn the country a downgrade, said David Riley, managing director for sovereign ratings at Fitch.

“We’re going to find out over the coming months if that a compromise will be the case or not,” Riley said. “There isn’t that much time.”

The US needs a combination of increased revenue and reduced spending, Mr. Riley said. That plan needs to be bi-partisan and credible over the medium-term, he added, calling a Cliff-induced recession “wholly unnecessary.”

Rating agencies will also be watching talks on raising the debt ceiling next year. S&P cut the United States to AA-plus from AAA on 5 August 2011, blaming bitter debt debates that threatened to plunge the country into default and Republican obstruction during a process that was for years a formality.

If the same happens this time, Riley said, Fitch could slash its rating during the first half of the year.

That could cause more turmoil for uncertain markets.

When S&P cut the United States last year, markets reacted badly. The benchmark S&P 500 index slumped the Monday following, falling 6.7% to an 11-month low.

Paradoxically, US Treasury yields plunged as spooked investors stampeded to safe havens. The yield on the benchmark 10-yr T-Note fell to 2.32% on 8 August from 2.56% on 5 August and is now around 1.6%.

That same knee-jerk response may well be repeated. Investors need to hold billions and billions of dollars. Where else can they go? Noise out of a rating agency is not going to change that.

That’s particularly the case with the Eurozone in continued turmoil. The area’s 3 yrs and still going debt crisis is far from resolution.

Investors will likely have plenty of time to digest a downgrade. Countries that lose their AAA status typically take years to get the top rating back

S&P downgraded Australia in December 1986, and it took until February 2003 for its triple-A to be restored. Canada took from Y 1992 to 2002. Denmark was cut to AA-plus in Y 1983 and did not get upgraded back to AAA until Y 2001.

That is because sovereign cuts at the AAA level are relatively rare, coming on issues that take years to resolve.

There is a reason why countries lose top ratings only with difficulty. If the United States does indeed hold onto its AAA from Fitch and its Aaa from Moody’s, and its one-notch lower rating of AA-plus from S&P it could happen because the world’s biggest economy proves its resilience once again.

“When you’re looking at the U.S. from this side of the Atlantic, you say the outlook looks quite good compared to the UK and the rest of Europe,” Fitch’s Riley said.

US GDP is expected to rise at a 2.2% annual rate in Y 2013, compared with 0.3% annual growth in the Eurozone and 1.1% in the United Kingdom, according to Thomson Reuters.

“If you can resolve this gridlock in Congress and provide some clarity, there’s probably upside to the US economy,” Mr. Riley added.

Paul A. Ebeling, Jnr.Paul A. Ebeling, Jnr. writes and publishes The Red Roadmaster’s Technical Report on the US Major Market Indices, a weekly, highly-regarded financial market letter, read by opinion makers, business leaders and organizations around the world.Paul A. Ebeling, Jnr has studied the global financial and stock markets since 1984, following a successful business career that included investment banking, and market and business analysis. He is a specialist in equities/commodities, and an accomplished chart reader who advises technicians with regard to Major Indices Resistance/Support Levels.

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