Fitch Ratings has affirmed its ratings on the U.S. sovereign at “AAA”, but it also dropped its outlook on the rating to negative, suggesting a downgrade is possible in the next two years.
The rating agency says its affirmation of the U.S. sovereign rating “reflects still strong economic and credit fundamentals. U.S. sovereign liabilities, both the dollar and Treasury securities, remain the global benchmark and accordingly the U.S. credit profile benefits from unparalleled financing flexibility and enhanced debt tolerance, even relative to other large ‘AAA’-rated sovereigns.” Additionally, it says that the U.S. dollar’s status as the pre-eminent global reserve currency and depth of the U.S. Treasury market mean financing risks are minimal.
However, the move to a negative outlook reflects Fitch’s “declining confidence that timely fiscal measures necessary to place U.S. public finances on a sustainable path and secure the U.S. ‘AAA’ sovereign rating will be forthcoming”, following failure of the so-called Congressional super-committee to agree on cuts to the federal budget deficit.
Fitch says that failure “underlines the challenge of securing broad-based consensus on how to reduce the out-sized federal budget deficit.”
“Agreement and implementation in 2013 of a credible medium-term deficit reduction plan that would stabilise government indebtedness in the latter half of the decade would relieve downward pressure on the U.S. sovereign ratings, though by postponing the difficult decisions on tax and spending until after forthcoming Congressional and Presidential elections, the scale and pace of required deficit reduction will consequently be greater. Conversely, failure to reach agreement in 2013 on a credible deficit reduction plan and a worsening of the economic and fiscal outlook would likely result in a downgrade of the U.S. sovereign rating,” it says.
Fitch also says that further deficit reduction will not be credible if it relies solely on further cuts in discretionary spending rather than reform to entitlements and taxation.
The negative outlook indicates a slightly greater than 50% chance of a downgrade over a two-year horizon. Fitch says it will shortly publish its revised economic and fiscal projections for the U.S. and will conduct a further review of its sovereign ratings in 2012.
Fitch’s current forecast for the U.S. is that the economic recovery will regain momentum in the latter half of next year and into 2013, and that a period of above trend growth will be subsequently followed by growth of at least 2.25% over the long term. However, Fitch notes that there is considerable uncertainty surrounding the economy’s potential output and scope for a period of above trend economic growth. “The longer productive capacity remains idle and unemployment high, the greater the likelihood that the loss of output (and tax receipts) is greater than currently estimated, with negative implications for the medium to long-term fiscal outlook,” it says.
Its latest fiscal projections see federal debt held by the public exceeding 90% of GDP and debt interest consuming more than 20% of tax revenues by the end of the decade, and gross general government debt (including the debt of state and local governments) reaching 110% of GDP over the same period. Fitch says that such a level of government indebtedness “would no longer be consistent with the U.S. retaining its ‘AAA’ status despite its underlying strengths.”
“Such high levels of indebtedness would limit the scope for counter-cyclical fiscal policies and the U.S. government’s ability to respond to future economic and financial crises,” it concludes.