Live Blogging The S&P Conference Call
Live blogging the S&P conference call. The Q&A session will be critical.
11:36: Conference call has started - Nothing new for now. Basically recapping that S&P has only changed the US outlook to negative: a one in three chance the rating could be lowered in 2 years. Or conversely, a two thirds chance the rating may not change.
11:38: The primary reasons for the decision are the fiscal problems the US is grappling with and the rising US debt.
11:40: S&P believes it will be difficult to reach a meaningful deal on fiscal consolidation between democrats and republicans over the next two years. Whether the rating will change will depend on two things: i) scale of such an agreement, and ii) whether the mechanics of such an agreement begin to be implemented, and whether the measure being implemented are viewed as credible.
Nikola Swann takes over:
11:41: The revision to negative reflects the fiscal story: there has been a very large budget deficit; budget deficits are over 10% of GDP; it has been more than 2 years since US fiscal problem began and US policymakers still have to decide how to address these. Fact is we still do not have an agreement between congress and the administration what the plan will be moving forward.
11:42: Base Case Projections: 3% annual real growth in the next 3 years. Expect deficits to remain over 6% of GDP by the end of 2013. By 2013 general debt would reach 84% of GDP. In downside case (double dip): general debt would be well over 90% of GDP.
11:44: Chances are small that an effective plan will be put in place for the 2012 election. If Congress and President do not succeed in coming to an agreement to consolidate fiscally by 2013, which S&P views as credible, in that circumstance, we would expect to downgrade the US.
11:45: US has been slowest of all developed countries to implement a credibile fiscal plan: compares US to UK and France, which are shown as better countries;
John Chambers takes over
11:46: The fiscal problems of the US are not a short-term issue: they are relevant for the medium and long-term. Clarifies that S&P does not make policy recommendations. Just opines on likelihood that it delivers the goods.
1. General question from the group: has the US ever had a rating other than AAA? Answer: no.
2. Has the US ever had a negative outlook? Answer: no.
3. Which AAA-rated peers have a better fiscal position than the US: Answer: UK, France, Germany and Canada, all of which are rated AAA, and have stable outlooks. UK had negative outlook in 2009, but since then S&P believes UK has implement a fiscal consolidation plan which the rating agency believes is credible. "The US has yet to agree on a plan." Canada has the best fiscal position of the group.
4. What effect will this action have on the outlook of AAA-rated US issuers? Answer: "very little impact" - the reason is that the AAA-universe has been in a secular decline. S&P does not believe the sovereign rating directly impacts other issuers. Put another way, S&P does not have a "sovereign ceiling policy." There may bee som structured finance/public debt issues where there may be an impact. Those will be dealt with on a case by case basis.
5. Impact on GSEs? Answer: don't have issuer ratings on Freddie and Fannie, so no impact.
6. What does credit risk mean when the borrower can monetize its own debt? Answer: In the US, or any other central bank country, S&P has always thought that it is very short sighted to say government can not default if US can print its way out. Counterintuitively, US should never have to levy any taxes and just monetize all deficits. That is not a credible or realistic alternative to levying taxation. The short answers is that in longer term, if deficits continue to rise, this impairs the credit standing of a gov't including the US.
7. What interest rate assumption does S&P use for the US over 2011-2012 and what is the proper fiscal ratio? Answer: have assumed real interest rate in 2011 at short end of 0.5% and 2.8% at 10 year mark. Compared to current real rates, these are much higher. Then expect short term real rates to increase to 1.5%, and the 10 Year to come down to 2.5%. Fiscal metric used is "net debt."
8. Many questions on states and municipalities. Any discussion? Answer: Don't expect to change outlooks of US states just because changing outlook on US gov't, because from comparative perspective fiscal reliance/relationship between US states and the Fed government relative to other federal systems, is much weaker, that's the fundamental reason. However, will be looking at particular issue ratings where there is a link, and will take action there in the coming days
9. Did you incorporate the amount of US muni debt in the rating decision? Answer: Yes
10. Do you differentiate ratings between issuers of currency and uses of currency? Answer: not sure what question means. Outlook applies to overall creditworthiness of US govt. S&P does factor in for monetary flexibility and can control its currency, unlike for example countries that use euro or smaller countries that are not likely to affect ECB policy.
11. Why Now? Answer: S&P has been looking at the proposals coming from the administration and the House, and have been taking note of the gradual deterioration of the US fiscal profile. When pull all this together, especially following last year's tax cut decision, the US fiscal profile is increasingly diverging from the profile of its AAA peers. Given the uncertainties in the admin and in Congress to halt the upward movement in the fiscal trajectory, thought this was the time to update the opinion.
12. How much would GDP growth have to fall short to materially increase the probability of a downgrade. Answer: Depends on how policymakers respond to a weaker growth scenario. Not suggesting that if avg growth is 2.9% that will then move the needle one way or another. GDP is not key variable: 3% is not the dealbreaker necessarily.
13. Would your outlook change if there is another round of QE? When do you see the start of a tightening cycle. Answer: to QE: no. On hiking, was address previously.
14. What are your inflation assumptions? Answer: 3% inflation in 2011; 2% in 2012-2014.
Additionally, below are the generic questions prepared by S&P in the just released: "A Closer Look At The Revision Of The Outlook On The U.S. Government Rating"
On April 18, 2011, Standard & Poor's Ratings Services revised its outlook on its 'AAA' long-term sovereign credit rating on the government of the United States of America to negative (see "United States of America ‘AAA/A-1+’ Rating Affirmed; Outlook Revised To Negative," RatingsDirect). Below are answers to questions that we anticipate market participants might ask in connection with this rating action.
Questions And Answers
What is Standard & Poor's current opinion on the U.S. government's creditworthiness?
Standard & Poor's sovereign credit rating on the U.S. federal government is still 'AAA/A-1+'. We define an entity with a 'AAA' long-term rating as one that, in our opinion, has an extremely strong capacity to meet its financial commitments. 'AAA' is the highest issuer credit rating we assign.
The ratings on the U.S. primarily reflect our opinion of the U.S.'s high-income, highly diversified, and exceptionally flexible economy. The ratings also reflect our view of the U.S.'s strong track record in terms of growth-enhancing policies as well as the unique advantages coming from the U.S. dollar's role as the world's key international currency.
When did Standard & Poor's first rate the U.S. government 'AAA'?
We first rated the U.S. 'AAA' in 1941, when Standard Statistics merged with Poor's Publishing. Both of the predecessor institutions to Standard & Poor's had also previously assigned their highest ratings to the U.S. government. Since that time, the U.S. government has maintained a 'AAA' credit rating and stable outlook.
What is the significance of Standard & Poor's negative outlook on the U.S.?
A negative outlook indicates our view regarding the potential direction of a long-term credit rating, typically over a period of six months to two years. An outlook is not necessarily a precursor of a rating change. For investment-grade credits, we assign positive or negative outlooks when we believe that there is an at least one-in-three likelihood that we could take a rating action over the ensuing two years.
Why did Standard & Poor's revise its outlook on its rating on the U.S. to negative?
We explain the reasons for our decisions in "United States of America ‘AAA/A-1+’ Rating Affirmed; Outlook Revised To Negative." These include our view that there is a material risk that efforts to reduce future U.S. government budget deficits will fall well below the $4 trillion and $4.4 trillion medium-term targets that Congressional leaders and the Administration separately set out earlier this month.
What factors might influence Standard & Poor's decision on whether to lower its 'AAA' rating on the U.S. government?
Now that Congressional Republicans and the Obama Administration have outlined their medium-term fiscal consolidation proposals, we will focus on two issues: first, whether agreement can be reached on a program that would reduce projected budget deficits by the target of $4 trillion over the coming decade, and, second, if so, the nature and likely effectiveness of the legislative decisions and assumptions underlying the program.
Standard & Poor's takes no position on the mix of spending and revenue measures the Congress and the Administration might conclude is appropriate. But for any plan to be credible, we believe that it would need to secure support from a cross-section of leaders in both political parties.
How could a government like the United States, which borrows in its own currency and conducts an independent monetary policy, be rated anything other than 'AAA'?
The ability of a government to finance itself in local currency and to conduct a monetary policy chiefly focused on domestic conditions is a hallmark of high credit standing. However, in our opinion, it is not sufficient to assure a 'AAA' sovereign rating. If, for example, fiscal settings are weak and show no prospect of correction, these abilities could diminish over time.
Can a government whose currency is the world's reserve currency not be rated 'AAA'?
We consider having the world's reserve currency to be a strength to the U.S. government's credit profile. However, there can be reserve asset demand for the currency of a sovereign that is experiencing a weakening of its credit profile, as in the case of Japan (AA-/Stable/A-1+), which Standard & Poor's downgraded most recently in January 2011.
How does the fiscal profile of the U.S. government compare with that of other 'AAA' sovereigns?
The general (i.e., federal plus state and local) government primary (i.e., before interest expense) deficits of the U.S. are materially higher than the other 'AAA' G7 governments. These deficits make the U.S. government's debt trajectory steeper than its peers', though in our view the 2010 starting position is comparable.
Would U.S. government public finances be affected if real (inflation-adjusted) interest rates increase?
We believe public finances would likely be affected for two reasons. First, prospective budget deficits, while likely to decline somewhat, would be more costly to finance than currently. Second, the maturity structure of U.S. federal government debt is relatively short (an average of 4.8 years) compared with those of some other highly rated sovereigns, with the result that maturing debt would also be more costly to refinance. We currently project that real interest rates will rise from negative 2 1/2% at the shortest end of the government yield curve and positive 1% at the 10-year point to positive 0.5% and positive 2.8% in 2012, respectively. In our view, if real interest rates rose more than our forecast, we think the U.S. would likely be experiencing something close to our pessimistic case forecast for growth and the attendant weak fiscal performance.
How does the U.S. government's external profile compare with that of other 'AAA' sovereigns?
The current account deficit of the U.S. has narrowed, which has helped to stabilize the ratio of net external debt to current account receipts. However, because the U.S. economy has a smaller amount of exports as a share of GDP than the economies of the other 'AAA' G7 nations and because the U.S. ran high current account deficits for an extended period, the U.S. is proportionately much more externally leveraged than other 'AAA' rated sovereigns.
Did the percentage of foreign holdings of U.S. government federal debt contribute to Standard & Poor's decision to revise the outlook to negative?
After having risen sharply since 1980, the percentage has stabilized at about 47% in the last two years. In part, this reflects the reserve currency status of the U.S. dollar and the high reserve accumulation of central banks in Asia and the Middle East. Foreign central banks and other official institutions account for three-quarters of the foreign holdings. Thus, the asset and currency allocation decisions affecting a large stock of U.S. government debt are concentrated in relatively few hands, and we are of the view that this concentration could create risks for discontinuous movements in the dollar exchange rate.
How do the U.S.'s growth prospects compare with those of other 'AAA' sovereigns?
For the next three years, we are projecting slightly less per capita GDP growth for the U.S. than for Germany and slightly more than for Canada, France, and the U.K. (see Chart 3). Part of the more favorable growth projections pertain to milder headwinds from a slower fiscal consolidation.
Did the Federal Reserve Board's program of quantitative easing contribute to your decision to revise the outlook to negative?
No. We find that risks of deflation in the U.S. have lessened and that there are few indications that inflation expectations have become untethered. Although it will be challenging to sequence the unwinding of these operations while raising policy interest rates once the recovery has become firmly rooted, we believe that the credibility of monetary policy will continue to be a credit strength for the U.S.
Do the finances of the U.S. government-supported enterprises (GSEs) affect the U.S. sovereign rating?
Yes. We estimate that the government might have to inject up to $280 billion to cover losses at Fannie Mae and Freddie Mac; this includes $148 billion already spent. (Both GSEs are already in conservatorship.) Moreover, by our estimates, that $280 billion could swell to $685 billion if the government capitalizes Fannie and Freddie on a commercial basis.
Why is Standard & Poor's assigning a negative outlook when the government has had a higher debt burden as a percent of GDP in the past than it does now or is likely to have by 2013?
U.S. federal debt held by the public reached a peak of 109% of GDP in 1946, significantly more than the 62% it was at the end of 2010 or the approximately 75% we expect it to be by 2013. Since the exceptional spending related to the Second World War led to the increase in that ratio in 1946 (compared with only 44% in 1940) and war spending was ending, it was reasonable to expect the ratio to soon decline, and it did: By 1950, the ratio dropped to 80%, and it continued to fall for years thereafter. Besides, in the first decades after World War II, the U.S. was the paramount global economic power, its debt was largely held domestically, and its currency was one of the very few that was freely convertible worldwide. In those unique historical circumstances, the U.S.'s high, though declining, government debt burden weighed far less on our opinion of its credit standing than it does now.
Today, sizable amounts of U.S. government debt are held abroad and financial markets are integrated, with the dollar and other most other currencies freely convertible. The U.S. must fund its fiscal deficits in highly competitive global capital markets. From our perspective, that means the U.S. government's debt burden cannot continue on an upward trajectory without harming its credit standing.
Does Standard & Poor's think that the U.S. government is about to default on its debt?
No. Since 1975, no sovereign rated 'AAA', 'AA', or 'A' has defaulted within 15 years from the time it had a rating in one of these categories. If we do lower the U.S. sovereign rating over the next two years, we currently expect that the downgrade would be no more than one notch (to 'AA+'), which would denote only a mild deterioration in our view of the U.S.'s relative credit standing.
Do the debates about passing Congressional continuing resolutions or raising the debt ceiling influence your decision to revise the outlook?
The congressional debates did not, by themselves, prompt us to revise the outlook. But we believe that these debates do highlight the political challenges in reducing the U.S.'s government's fiscal deficit. That said, we do not expect the U.S. government to default because of a Congressional refusal to authorize the government to borrow additional funds.
Will Standard & Poor's assign a negative outlook to its ratings on U.S.-based issuers because of the negative outlook on the U.S. government rating?
As a general matter, a change in the rating or outlook on a sovereign does not necessarily lead to a change in the rating or outlook on other similarly rated issuers located in that country. We could revise the outlook when there are individual rated issuers or issues in the U.S. with features meaningfully linking them to a potential weakening in the U.S. government's credit standing, but we do not currently expect many such actions. We also do not currently expect to revise the outlooks on any 'AAA' rated corporate issuers as a result of this action. Note also that Standard & Poor's continues to view transfer and convertibility risk--the risk that the U.S. government would limit the ability of other issuers to secure foreign exchange to make debt-service payments--as 'AAA' remote. We'll be looking at these factors on a case-by-case basis.
How does the outlook revision on the U.S. government affect U.S. public finance ratings?
Although many economic factors are similar and some expenditure responsibilities are linked, we do not directly tie U.S. state and local government ratings to the rating on the U.S. federal government. U.S. states have significant abilities to raise revenues and alter expenditures relative to regional governments in other countries. Likewise, most U.S. local government operating revenues come from the state or local levels, and state laws govern most provisions for local revenues and debt issuance. Public finance ratings on issues secured by federal revenues might also remain unaffected to the extent that we believe other risks already limit the rating.
Is it common for Standard & Poor's to downgrade 'AAA' rated sovereigns?
Lowering a 'AAA' sovereign credit rating is not an uncommon occurrence. Chart 1 shows the stability of 'AAA' sovereign ratings since 1975. For sovereigns rated 'AAA' on Jan. 1 of a given year, on average, 98% were rated 'AAA' one year later, 93% three years later, 89% five years later, 78% 10 years later, and 71% 15 years later.
On Feb. 24, 2011, Standard & Poor's converted its rating on the U.S. government to unsolicited. Is there a connection between that announcement and the negative outlook?
No. As explained in the February release, this announcement was prompted to comply with Article 10(5) of EU Regulation 1060/2009, to which Standard & Poor's, as a rating agency with offices in Europe, is subject. Article 10(5), which addresses matters relating to the disclosure and presentation of credit ratings, requires--among other things--that unsolicited credit ratings be identified as such. Standard & Poor's considers a sovereign rating to be unsolicited when we do not have a rating agreement with the government, and the U.S. falls into that category. Currently, 15 of the 127 sovereigns rated by Standard & Poor's are unsolicited.