Standard & Poor's followed Germany's Feri ratings agency, on Friday, by downgrading the creditworthiness of the US, the world's largest borrower. Below we print a slightly abridged version of the US agency's reasoning for the cut, from AAA to AA+.
Key macroeconomic assumptions in the base case scenario include trend real GDP growth of 3% and consumer price inflation near 2% annually over the decade.
Our revised upside scenario–which, other things being equal, we view as consistent with the outlook on the ‘AA+’ long-term rating being revised to stable–retains these same macroeconomic assumptions. In addition, it incorporates $950 billion of new revenues on the assumption that the 2001 and 2003 tax cuts for high earners lapse from 2013 onwards, as the Administration is advocating. In this scenario, we project that the net general government debt would rise from an estimated 74% of GDP by the end of 2011 to 77% in 2015 and to 78% by 2021.
Our revised downside scenario–which, other things being equal, we view as being consistent with a possible further downgrade to a ‘AA’ long-term rating–features less-favorable macroeconomic assumptions, as outlined below and also assumes that the second round of spending cuts (at least $1.2 trillion) that the act calls for does not occur.
This scenario also assumes somewhat higher nominal interest rates for US Treasuries. We still believe that the role of the US dollar as the key reserve currency confers a government funding advantage, one that could change only slowly over time, and that Fed policy might lean toward continued loose monetary policy at a time of fiscal tightening.
Nonetheless, it is possible that interest rates could rise if investors re-price relative risks. As a result, our alternate scenario factors in a 50 basis point (bp)-75 bp rise in 10-year bond yields relative to the base and upside cases from 2013 onwards.
In this scenario, we project the net public debt burden would rise from 74% of GDP in 2011 to 90% in 2015 and to 101% by 2021.
Our revised scenarios also take into account the significant negative revisions to historical GDP data that the Bureau of Economic Analysis announced on July 29. From our perspective, the effect of these revisions underscores two related points when evaluating the likely debt trajectory of the US government.
First, the revisions show that the recent recession was deeper than previously assumed, so the GDP this year is lower than previously thought in both nominal and real terms. Consequently, the debt burden is slightly higher. Second, the revised data highlight the sub-par path of the current economic recovery when compared with rebounds following previous post-war recessions.
We believe the sluggish pace of the current economic recovery could be consistent with the experiences of countries that have had financial crises in which the slow process of debt deleveraging in the private sector leads to a persistent drag on demand. As a result, our downside case scenario assumes relatively modest real trend GDP growth of 2.5% and inflation of near 1.5% annually going forward.
When comparing the US to sovereigns with ‘AAA’ long-term ratings that we view as relevant peers – Canada, France, Germany, and the UK – we also observe, based on our base case scenarios for each, that the trajectory of the US’s net public debt is diverging from the others. Including the US, we estimate that these five sovereigns will have net general government debt to GDP ratios this year ranging from 34% (Canada) to 80% (the UK), with the US debt burden at 74%. By 2015, we project that their net public debt to GDP ratios will range between 30% (lowest, Canada) and 83% (highest, France), with the US debt burden at 79%.
However, in contrast with the US, we project that the net public debt burdens of these other sovereigns will begin to decline, either before or by 2015.
Standard & Poor’s transfer T&C assessment of the U.S. remains ‘AAA’. Our T&C assessment reflects our view of the likelihood of the sovereign restricting other public and private issuers’ access to foreign exchange needed to meet debt service. Although in our view the credit standing of the US government has deteriorated modestly, we see little indication that official interference of this kind is entering onto the policy agenda of either Congress or the Administration.
Consequently, we continue to view this risk as being highly remote.
The outlook on the long-term rating is negative. As our downside alternate fiscal scenario illustrates, a higher public debt trajectory than we currently assume could lead us to lower the long-term rating again.
On the other hand, as our upside scenario highlights, if the recommendations of the Congressional Joint Select Committee on Deficit Reduction – independently or coupled with other initiatives, such as the lapsing of the 2001 and 2003 tax cuts for high earners – lead to fiscal consolidation measures beyond the minimum mandated, and we believe they are likely to slow the deterioration of the government’s debt dynamics, the long-term rating could stabilize at ‘AA+’.