S&P cuts long-term rating to AA+ from AAA on concerns of the US govt’s budget deficit and rising debt burden.
Standard & Poor’s downgraded the US’s AAA credit rating for the first time, slamming the nation’s political process and criticising lawmakers for failing to cut spending enough to reduce record budget deficits.
S&P lowered the US one level to AA+ while keeping the outlook at “negative” as it becomes unlikely Congress will end Bush-era tax cuts or tackle entitlements. The rating may be cut to AA within two years if spending reductions are lower than agreed to, interest rates rise or “new fiscal pressures” result in higher general government debt, the New York-based firm said.
Lawmakers agreed on August 2 to raise the nation’s $14.3 trillion debt ceiling and put in place a plan to enforce $2.4 trillion in spending reductions over the next 10 years, less than the $4 trillion S&P had said it preferred. Even with the specter of a downgrade, demand for treasuries surged as investors saw few alternatives amid slowing global growth and Europe’s deepening sovereign debt crisis.
“The downgrade reflects our opinion that the fiscal consolidation plan that Congress and the administration recently agreed to falls short of what, in our view, would be necessary to stabilise the government’s medium-term debt dynamics,” S&P said in a statement late Friday.
US RESPONSE
The US lashed out at S&P, with a Treasury Department spokesman saying the firm’s analysis contains a $2 trillion error. The spokesman, who didn’t want to be named refused to elaborate much.
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Moody’s Investors Service and Fitch Ratings affirmed their AAA credit ratings on August 2, the day President Barack Obama signed a bill that ended the debt-ceiling impasse that pushed the Treasury to the edge of default. Moody’s and Fitch also said that downgrades were possible if lawmakers fail to enact debt reduction measures and the economy weakens.
“This move should not be much of a surprise to markets, though the timing is at a point where market sentiment is fragile after the drop in stocks this week,” said Ajay Rajadhyaksha, MD, Barclays Capital in New York. “What really matters is whether the markets are willing to ‘downgrade’ the US bond market. As this week’s move showed, US Treasuries remain the flight-to-quality asset of choice.”
ASIAN INVESTORS
Asian investors are likely to retain their Treasuries holdings for now, with options limited by the region’s foreign- exchange rate policies. Japan, the second-largest global investor in the US government debt, sees no problem with trust in the securities, a Japanese government official said on condition of anonymity.
Policy makers from China to Japan to Southeast Asia are lured to Treasuries as a result of efforts to stem gains in their currencies against the dollar, which would impair export competitiveness. China has accumulated $1.16 trillion in the securities and the nation’s official Xinhua News Agency said in a commentary that the US must cure its “addiction” to borrowing.
“They won’t be happy about it, but Asian central banks will just have to hold on and stick it out,” said Sean Callow, a senior currency strategist at Westpac Banking Corp. in Sydney. “There is pressure on them to hold on to liquid assets and there is nothing more liquid than the Treasury market. At least Treasuries have been doing well and they aren’t holding on to distressed assets.”
US ECONOMY
S&P’s action may hurt the US economy over time by increasing the cost of mortgages, auto loans and other types of lending tied to the interest rates paid on Treasuries. JPMorgan Chase & Co. estimated that a downgrade would raise the nation’s borrowing costs by $100 billion a year. The U.S. spent $414 billion on interest expense in fiscal 2010, or 2.7 percent of gross domestic product, according to Treasury Department data.
“It’s a reflection of the fact that we haven’t done enough to get our fiscal house in the order,” Anthony Valeri, market strategist in San Diego at LPL Financial, which oversees $340 billion, said in an interview before the cut. “Sovereign credit quality is going to remain under pressure for years to come.” The agreement between Republicans and Democrats raised the nation’s debt ceiling until 2013 and threatens automatic spending cuts to enforce the $2.4 trillion in spending reductions over the next 10 years. Even with the accord, S&P said the U.S.’s debt may rise to 74 percent of gross domestic product by year-end, to 79 percent in 2015 and 85 percent by 2021.
S&P also changed its assumption that the 2001 and 2003 tax cuts enacted under President George W. Bush would expire by the end of 2012 “because the majority of Republicans in Congress continue to resist any measure that would raise revenues.”
“More broadly, the downgrade reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges to a degree more than we envisioned when we assigned a negative outlook to the rating,” S&P said. S&P put the U.S. government on notice on April 18 that it risked losing the AAA rating it had since 1941 unless lawmakers agreed on a plan by 2013 to reduce budget deficits and the national debt. It indicated last month that anything less than $4 trillion in cuts would jeopardize the rating.
“There was still a very narrow cross section of common ground between the parties and we don’t think that this agreement really changes that equation,” David Beers, a managing director of sovereign credit ratings at S&P said in a Bloomberg Television interview.
S&P gives 18 sovereign entities its top ranking, including Australia, Hong Kong and the Isle of Man, according to a July report. The UK which is estimated to have debt to GDP this year of 80 per cent, 6 percentage points higher than the US, also has the top credit grade. In contrast with the US, its net public debt is forecast to decline either before or by 2015, S&P said in the statement yesterday.