DBRS Joins Fitch Placing United States' AAA Rating On Watch Negative
With its CDS trading like an emerging market, it is likely no surprise that Fitch Ratings has placed the United States' 'AAA' Long-Term Foreign-Currency Issuer Default Rating (IDR) on Rating Watch Negative.
CDS is trading like USA is anything but AAA-rated...
With Fitch placing the United States' 'AAA' rating on Rating Watch Negative, here is an update of a very old chart I used to published: Composite Credit Rating (across the agencies) vs. 5Y CDS Across Select Countries. For obvious reasons, US CDS isn't trading in the AAA range. pic.twitter.com/yzyN4jluA8— Michael McDonough (@M_McDonough) May 25, 2023
The T-Bill curve is not buying the calm picture being painted by Washington with the June 1st Bill yielding 7.00% today...
Fitch Key Rating Drivers:
Debt Ceiling Brinkmanship: The Rating Watch Negative reflects increased political partisanship that is hindering reaching a resolution to raise or suspend the debt limit despite the fast-approaching x date (when the U.S. Treasury exhausts its cash position and capacity for extraordinary measures without incurring new debt). Fitch still expects a resolution to the debt limit before the x-date. However, we believe risks have risen that the debt limit will not be raised or suspended before the x-date and consequently that the government could begin to miss payments on some of its obligations. The brinkmanship over the debt ceiling, failure of the U.S. authorities to meaningfully tackle medium-term fiscal challenges that will lead to rising budget deficits and a growing debt burden signal downside risks to U.S. creditworthiness.
Debt Limit Reached: The U.S. reached its $31.4 trillion debt limit on Jan. 19, 2023, and the Treasury began taking extraordinary measures in order to avoid breaching the ceiling. The Treasury has stated that these extraordinary measures could be exhausted as early as June 1, 2023. The cash balance of the Treasury reached USD76.5 billion as of May 23 and sizeable payments are due June 1-2, meaning that the x-date could arrive as the Treasury indicated and before an agreement is reached or finalized with votes in the House and Senate.
X-Date Approaching: The failure to reach a deal to raise or suspend the debt limit by the x-date would be a negative signal of the broader governance and willingness of the U.S. to honor its obligations in a timely fashion, which would be unlikely to be consistent with a 'AAA' rating, in Fitch's view. Prioritization of debt securities over other due payments after the x-date would avoid a default. Similarly, avoiding default by non-conventional means such as minting a trillion-dollar coin or invoking the 14th amendment is unlikely to be consistent with a 'AAA' rating and could also be subject to legal challenges.
Debt Default Rating Implications: We believe that failing to make full and timely payments on debt securities is less likely than reaching the x-date and is a very low probability event. Such a failure would be a debt default under Fitch's sovereign rating criteria and would lead us to downgrade the sovereign IDR to Restricted Default (RD). Affected debt securities would be downgraded to 'D'. Additionally, other LT debt securities with payments due within the following 30 days would likely be downgraded to 'CCC', and ST treasury bills maturing within the following 30 days would likely be downgraded to 'C'.
Potential Post-Default Ratings: Other debt securities with payments due beyond 30 days would likely be downgraded to the expected post-default rating of the IDR. A key consideration in determining the U.S. post-default rating would be Fitch's Sovereign Rating Model (SRM) - the details of which are in the public domain. The SRM output for the U.S. stands at 'AA+'. The model applies a two-notch reduction for a sovereign that has recently defaulted, suggesting that Fitch's model-implied post-default rating would be 'AA-'. The final rating could be adjusted lower or higher via the Qualitative Overlay as per our criteria. Fitch would expect any debt default to be relatively short-lived. However, a more protracted default scenario could have more severe implications for the country's post-default ratings.
Country Ceiling to Remain at 'AAA': Fitch would expect the U.S country ceiling to remain at 'AAA' even in the scenario of a debt default. The U.S. dollar is the preeminent world's reserve currency, and we view the risk of exchange and capital controls as de minimis.
Governance Challenges: Governance is a weakness relative to 'AAA' rated peers, and the future direction of the rating is sensitive to the direction it takes. The contested 2020 presidential election, brinkmanship over the debt limit to advance political agendas, and failure to reach consensus on the country's fiscal challenges are recent signs of the deterioration in governance. Additionally, the absence of a medium-term fiscal framework and a complex budgeting process has contributed to the failure to reverse successive debt increases caused by economic shocks and other fiscal accommodations. Political partisanship has brought about repeated debt-limit brinkmanship and led to near-default episodes that could erode confidence in the government's repayment capacity.
Weakening Fiscal Outturns: Weaker-than-expected tax receipts and higher interest rates have led public finances to modestly underperform Fitch's expectations at the last review. Fitch now forecasts a general government deficit at 6.5% of GDP in 2023 and 6.9% of GDP in 2024, up from 5.5% in 2022. State and local governments overall surpluses in 2021-22 have begun to move to deficits, which accounts for part of the expected general government deterioration. A rising interest burden and growing spending on entitlements over the coming decade will keep the deficits at above 7% of GDP on average. Between 2023 and 2033 the U.S. Congressional Budget Office (CBO) May 2023 baseline includes a 2.2pp of GDP rise in spending on interest, healthcare and social security that is linked to demographics, a rising interest burden and healthcare costs.
High and Rising Public Debt Burden: General government debt fell to 112.5% of GDP at year-end 2022 (compared to 36.1% for the 'AAA' median), a decline from its 2020 pandemic peak of 122.3%. However, the ratio remains over 12 pp above pre-pandemic levels in 2019. Fitch forecasts debt to increase to 117% by end-2024. Debt dynamics under the baseline Congressional Budget Office (CBO) assumptions project that the ratio of federal debt held by the public to GDP will approach 119% within a decade under the current policy setting, a rise of over 20 pp. Interest rates have risen significantly over the last year with the 10-year Treasury yield at close to 3.7% (compared to 2.8% a year ago).
Exceptional Strengths Support Ratings: The size of the country's economy, high GDP per capita and dynamic business environment support the U.S. ratings. The U.S. dollar is the world's preeminent reserve currency, which gives the government extraordinary financing flexibility.
ESG - Governance: The U.S. has an ESG Relevance Score (RS) of '5' Political Stability and Rights and '5[+]' for the Rule of Law, Institutional and Regulatory Quality and Control of Corruption. Theses scores reflect the high weight that the World Bank Governance Indicators (WBGI) have in our proprietary Sovereign Rating Model. The U.S. has a high WBGI ranking at 79, reflecting its well-established rights for participation in the political process, strong institutional capacity, effective rule of law and a low level of corruption.
This morning, DBRS Morningstar followed Fitch and placed the United States of America’s Long-Term Foreign and Local Currency – Issuer Ratings of AAA Under Review with Negative Implications. In addition, DBRS Morningstar placed the United States of America’s Short-Term Foreign and Local Currency – Issuer Ratings of R-1 (high) Under Review with Negative Implications.
KEY RATING CONSIDERATIONS
The Under Review with Negative Implications reflects the risk of Congress failing to increase or suspend the debt ceiling in a timely manner. If Congress does not act, the U.S. federal government will not be able to pay all of its obligations. The precise timing of when the federal government will exhaust available cash and extraordinary measures, the so-called X-date, is somewhat unclear. However, Treasury Secretary Janet Yellen reiterated her warning on May 22 that the X-date could come as early as June 1. Judging from the latest data on daily net inflows into the Treasury General Account, we believe it is reasonable to assume the X-date could arrive within weeks if not days.
While we still expect Congress to raise the debt ceiling before Treasury runs out of available resources, there is a risk of Congressional inaction as the X-date approaches. DBRS Morningstar would consider any missed payment of interest or principal as a default. In such a scenario, the relevant U.S. Issuer Ratings would be downgraded to “Selective Default.”
Alternatively, the U.S. Treasury may prioritize debt payments following the X-date in order to avoid a default. However, prioritizing debts payments for a meaningful period of time would likely lead to a rating action, as we assess that such a strategy would have a highly negative impact on the economy and could quickly run into legal and operational challenges. Similar challenges could arise if the Administration instructs the Treasury to ignore the debt limit or bypasses the debt limit through some other strategy. In addition, failure to lift the ceiling in a timely manner could indicate that political polarization is affecting the quality and predictability of U.S. policymaking.
Even if Congress ends up increasing the debt ceiling prior to the X-date, the prospect of repeated debt ceiling standoffs in a polarized political environment may lead DBRS Morningstar to judge that U.S. credit risk has increased to a level that is no longer consistent with a AAA rating.
While the debt ceiling impasse poses a potential threat to the United States’ AAA rating, the U.S. has exceptional strengths that support the credit profile. The U.S. economy is very large in scale, accounting for one-quarter of global output. The economy is highly resilient to shocks, given its diversification across industry and geography, its flexible labor market, and its global leadership position in terms of research and innovation. U.S. financial markets and the U.S. dollar are at the center of world trade and capital flows, which provides the U.S. with an unusually high degree of financing flexibility. In addition, the country benefits from well-established democratic institutions, a strong legal system, and transparent governance. While a late debt payment could erode the reputation of the dollar as the world’s primary reserve currency and U.S. government bonds as global safe-haven assets, the fundamental credit strengths of the U.S. would likely continue to support the ratings.
One potential outcome of the current negotiations is that the next debt ceiling discussion could be pushed out beyond next year’s election. Future congresses could overhaul the debt ceiling to reduce the threat of default or eliminate it entirely, although any action on this front would likely require bipartisanship to overcome a filibuster in the Senate.
The Review period will focus on whether Congress lifts the debt ceiling in a timely manner, how the U.S. Treasury responds if Congress is late to increase the debt ceiling, the economic and financial fallout if the federal government fails to pay its obligations on time, and the likelihood of recurring debt standoffs in the near term.
The rating could be confirmed at AAA if Congress lifts the debt ceiling in a timely manner, and risks stemming from debt ceiling brinksmanship in the near term are deemed to be relatively low.
The ratings could be downgraded if: 1) the U.S. Treasury fails to pay all of its debt obligations on time, 2) the federal government builds up material non-interest arrears, or 3) there is a high likelihood of repeated debt ceiling standoffs in a climate of heightened political polarization.
Paging Mrs. Yellen...
Who could have seen this coming?
*YELLEN: WANT TO AVOID TYPE OF DAMAGE SUFFERED IN 2011 SHOWDOWN— zerohedge (@zerohedge) May 24, 2023
True, it will be embarrassing when AAPL's credit rating is higher than the US