With short-term Treasury Bills starting to price in a missed payment possibility and USA CDS surging (though still low), the debt ceiling (and implicit chance of a technical default) is nigh. As we approach yet another debt ceiling showdown (especially in light of the seeming congruence of a CR and debt ceiling debate in an entirely divided Washington), market attention will turn towards a possible US sovereign rating downgrade. In this article, we provide an outline of the likely actions by the three rating agencies (S&P, Moody’s and Fitch).
US Credit Rating: Near term risks and outlook
The conclusions are:
In our base case scenario, where the debt ceiling is raised before the “X” date (date beyond which the Treasury cannot honor all its payments) and the government does not default on any of its obligations, Moody’s (Aaa/stable) and S&P (AA+/stable) would likely remain unchanged. Depending on how contentious the negotiations are, there is an increasing probability that Fitch downgrades the rating from AAA to AA as the “X” date is approached.
In the scenario where we move past the “X” date and the Treasury misses a debt payment (maturing or coupon), we expect S&P to quickly move to the “Selective Default” (SD) rating. Moody’s and Fitch are likely to downgrade the rating by one notch, with the possibility that Fitch moves to “Restrictive Default” if the default persists and several bonds are affected.
Inclusion of Treasuries in the BofA Merrill Lynch US Broad Market index will not be affected by a ratings downgrade of any amount. Local currency sovereign debt is explicitly exempt from the rating criteria of single currency indices (except the Euro Broad Market Index). Our view is that other major US bond indices would adopt such an exemption in the unlikely event that multiple rating agencies move their ratings to SD.