November 28, 2014

Political Turmoil Greatest Concern for Ratings Agencies

For those who follow the credit rating agencies’ assessments of the United States, the past several weeks have offered mixed messages. Overall, some improvement has been noted, mostly due to the steadily improving economy and the declining deficit. Concerns remain, however, about the long-term outlook and the ability of elected leaders to raise the nation’s debt ceiling without provoking a crisis.  

When Moody's Investors Services upgraded the U.S.'s credit-rating outlook from "negative" to "stable" last week, it warned that without further action in Congress, the rating could be under pressure again in the future.    

Moody's observed that, "over the longer term, a rise in the fiscal deficit associate[d] with pressure on government spending from health care and Social Security could also pressure the rating if not addressed."  

Nevertheless, Moody’s provided the most upbeat assessment for the U.S. of the three main agencies, which also include Fitch Ratings and Standard and Poor’s. Aside from the switch to a stable outlook, Moody’s maintained its AAA rating for the U.S..

In a June 28 report, Fitch Ratings also affirmed the AAA rating for the U.S. but kept its “Negative” outlook.  

While noting that “the economic recovery is gaining traction” and that the deficit “is now approaching a level consistent with debt stabilisation,” Fitch’s expressed concern that lawmakers will fail to resolve policy disagreements over the debt limit in a timely manner or avoid a government shutdown when spending authority for all federal agencies ends on September 30.

Fitch’s will conduct a further review before the end of the year. Among the factors to be taken into account will be how lawmakers’ handle upcoming fiscal deadlines.  “Avoidance of a ‘debt ceiling crisis’ and government shutdown,” Fitch’s said, “would suggest that despite profound political differences, there is a common willingness to avoid disruptive and regular episodes of ‘crisis’ and would be supportive of a stabilization of the Outlook.”

The most pessimistic of the three credit rating agency reports came from Standard and Poor’s on June 10, when it affirmed its AA+ rating for the U.S. 

Standard and Poor’s revised its long-term rating from “negative” to “stable.” This just means, however, “the likelihood of a near-term downgrade of the rating is less than one in three.”

Even more than the other two agencies, Standard and Poor’s cited political discord as a negative factor. It stated, “We believe that our current ‘AA+’ rating already factors in a lesser ability of U.S. elected officials to react swiftly and effectively to public finance pressures over the longer term in comparison with officials of some more highly rated sovereigns and we expect repeated divisive debates over rating the debt ceiling.” 

Despite their caveats, these reports might feed into an optimistic narrative that says the declining deficit and improving economy mean we can back away from efforts to rein-in the nation’s unsustainable structural budget deficit (i.e., a “grand bargain”).  

This is a false, if politically tempting, narrative and one that is not supported by the credit ratings reports. The need for a comprehensive fiscal plan is not about cutting the deficit in the near-term while the economy is still weak, but about putting the budget on a sustainable long-term track. 

As noted by Standard and Poor’s, “We see some risks that the recent improved fiscal performance, due in part to cyclical and to one-off factors, could lead to complacency. A deliberate relaxation of fiscal policy without countervailing measures to address the nation’s longer-term fiscal challenges could place renewed downward pressure on the rating.”