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What Is the U.S. Credit Rating? Lombardi Letter 2017-09-07 02:13:32 U.S. credit rating downgrade what is the U.S. credit rating U.S. government credit rating U.S. credit rating current U.S. credit rating U.S. credit rating downgraded U.S. credit rating downgrade 2011 The U.S. credit rating, still the envy of the world, could be coming under pressure in 2017 and beyond. Here's the full story. News,U.S. Economy https://www.lombardiletter.com/wp-content/uploads/2017/03/credit-rating-150x150.jpg

What Is the U.S. Credit Rating?

News - By Benjamin A. Smith |
credit rating

The Current U.S. Government Credit Rating

The U.S. credit rating—still the envy of the world—could be coming under severe pressure in 2017 and beyond. The specter of debt-ceiling negotiations, increased deficit spending, and huge tax cuts loom just beneath the surface, threatening to rile the credit agencies’ assessments if any missteps in the economy take place.

So what is the U.S. credit rating anyway? Put simply, it’s a numerical or alphabetical rating assigned by a Credit Rating Agency (CRA) as to the creditworthiness of U.S. sovereign debt, and how likely it deems the U.S. will pay that debt back. Somewhat similar to a personal credit rating score, CRAs rate individual country debt based on factors like an issuer’s assets, income, aggregate debt levels, expenses, and past financial history. CRAs assign different factor weightings in their models, but generally, most credit ratings agree with each other.

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There are also CRA “outlooks,” which always accompany the credit ratings themselves. This gives the CRA “bias” as to what their next move could be. For example, if the U.S. has a Triple-A rating that is accompanied by a negative outlook, it means the agency is looking closely at a downgrade. The agency always sets out its reasons for doing so. It might be the failure to pass a national budget or uncertainties regarding key economic policy decision.

Maintaining a pristine U.S. credit rating is of paramount importance to the U.S. economy. A poor rating can have adverse effects on interest rates, thus affecting the interest payments on the U.S. national debt. After all, if debt holders know the debt will be paid in full and on time, there’s no need to account default risk into the interest rate. A poor rating will also mean higher inflation, as it is inextricably linked with the interest rate. Capital flight, or at least a slowdown of capital attraction, would also accompany any U.S. credit rating downgrade, as U.S. debt payback may not be as “guaranteed” as once was. Capital flight would create upwards pressure on inflation and downward pressure on the U.S. dollar.

The government enjoys a current U.S. credit rating of Triple-A from the major CRAs, save for S&P, which has a Double-A rating with a stable outlook. Until as recently as 2011, it enjoyed the “gold standard” of Triple-A ratings from all three major CRAs (Fitch, Moody’s, and S&P) and was the only country in the world to attain this designation.

Major Credit Agency Ratings and Outlooks: United States Since 2000

Agency Rating Outlook Date
DBRS AAA stable Apr. 22 2014
Fitch AAA stable Mar. 21, 2014
Fitch AAA  negative watch Oct. 15, 2013
Moody’s Aaa stable Jul. 18, 2013
S&P AA+ stable Jun. 10, 2013
Fitch AAA negative Nov. 28, 2011
S&P AA+ negative Aug. 5, 2011
Moody’s Aaa negative Aug. 2, 2011
S&P AAA negative watch Jul. 14, 2011
Moody’s Aaa negative watch Jul. 13, 2011
S&P AAA negative Apr. 18, 2011
Fitch AAA stable Sep. 21, 2000

(Source: “United States | Credit Rating,” Trading Economics, last accessed March 28, 2017.)

This changed in August 5, 2011, when the U.S. credit rating downgraded to AA with a negative outlook from Triple-A by S&P. In fact, it was S&P’s first cut to America’s credit rating in 94 years, since it first granted it Triple-A status in 1917. This caused quite a stir in the markets, in one part because of the rarity of the event, in second part due to the potential negative consequences it could entail. As a testament to this, the Dow Jones Industrial Average fell 699 points in the week preceding the downgrade, the biggest weekly point drop in almost 3 years (October 2008).

Not coincidentally, the U.S. credit rating downgrade 2011 occurred less than a week after Congress finally agreed to spending cuts that would reduce the bloated deficit by more than $2.0 trillion. To avoid a downgrade, S&P said the United States needed to advance a plan to tackle the nation’s soaring debt, along with raising the debt ceiling in the near term. The “plan that Congress and the Administration recently agreed to falls short of what… would be necessary to stabilize the government’s medium-term debt dynamics.” (Source: “S&P downgrades U.S. credit rating,” CNN Money, August 6, 2011.)

The exact same dynamics are at play today, which is one reason why the stakes are so high. The U.S. is currently in a state of debt ceiling suspension. “Extraordinary measures” provisions have been triggered, which are accounting maneuvers the government can use to temporarily keep the debt under the “limit.” This maneuver would essentially legally prevent the United States from technically defaulting on its debt. (Source: “Bipartisan Budget Act of 2015,” U.S. Government Publishing Office, last accessed March 3, 2017.)

What Does a U.S. Triple-A Rating Mean to Consumers?

Quite a lot, actually. A strong U.S. government credit rating is a key driver of foreign and institutional demand for U.S. Treasury securities. This “risk free yield” grants actors, such as sovereign government running up large trade surpluses with America, to re-invest the proceeds back into “risk-free” paper, which in turn allows the government to purchase more goods. It acts like a revolving line of credit, except the guarantors principle is assured.

A strong rating also helps the dollar, as creditworthy nations tend to attract capital and suffer fewer capital outflows. With America running up habitual deficits over the past two decades (and no end in sight), maintaining sovereign and institutional monetary flows is key to dollar strength. The fact that the U.S. dollar is the world’s reserve currency is an essential advantage, but it’s an advantage that may be slipping over time. If the credit rating slips a couple of notches, it may end the dollar’s reign as the world’s reserve currency forever.

A sliding dollar would sting most consumers in the place it matter most—their pocketbooks. Goods of all types are bound to keep inching up if the dollar weakens. This would likely lead to higher inflation, and higher expectations of such and lower yields on financial assets tend to bring weaker currency in a sort of negative feedback loop.

Thus, the strong U.S. credit rating is the equalizing force keeping the interest rates for Treasury securities low, and U.S. dollar demand robust.

Fortunately, since practically all internal financial industry regulations allow unlimited institutional ownership of government AA+ bonds or higher, the United States is safe for now. However, things can change extraordinarily quickly, as the June 2016 Brexit vote showed.

It was then the United Kingdom had its AAA rating pulled after citizens voted to end its treaty association with the European Union. Logic had it that tax receipts would suffer from being apart from the EU’s wider trading bloc, with no assurances as to the viability of future bilateral trade agreements. S&P and Fitch both cut their rating, with S&P actually slashing the AAA rating down two full notches. It was the first time it had ever done this to a country which owned its top rating.

International Long-Term Debt Rating Scale

Investment Grade
AAA Highest credit quality. The risk factors are extremely low.
AA+
AA
AA-

Very high credit quality. Protection factors are very strong. Adverse changes in business, economic, or financial conditions would increase investment risk although not significantly.

A+
A
A-
High credit quality. Protection factors are good. However, risk factors are more variable and greater in periods of economic stress.
BBB+
BBB
BBB-
Adequate protection factors and considered sufficient for prudent investment. However, there is considerable variability in risk during economic cycles.

(Source: “Rating Scales & Definitions,” Global Credit Rating Co., last accessed March 28, 2017)

Could the Brexit scenario happen in America, where two-notch downgrades could force massive institutional and foreign debt holders into forced selling? Most certainly, if the U.S. doesn’t play its cards right.

Fitch has discussed the possibility of slashing their AAA rating, owing to Donald Trump’s plans to slash personal and corporate taxes. Trump’s plan calls for a reduction of the top income tax bracket from 39.6% to 33%, and corporate tax rates would be slashed from 35% down to 15%. Fitch is concerned about the impact slashing taxes would pose to the national deficit. “Trump’s plans to cut taxes by $6.2 trillion over the next 10 years that could add around 33 percent to U.S. government debt,” he added. The U.S. already has the highest debt levels of any Triple-A rated country. (Source: “Trump’s tax cuts may pressure U.S.’s top credit rating-Fitch,” CNBC, January 12, 2017.)

This scenario doesn’t even take into account the current debt ceiling, which is currently in limbo. Fitch has proclaimed that if the 2017 debt ceiling isn’t raised before the “extraordinary measures” provisions run out, this would entail a negative U.S. sovereign rating trigger. The “tail risk” of a missed debt service payment and fiscal non-compliance would be too damaging to support a AAA rating in lieu. The exact “x” date isn’t known, but it’s expected to be sometime in the fall 2017.

So there are currently two plausible ways more U.S. credit downgrades 2017/2018 could be forthcoming.

Famed investor Dr. Marc Faber once said “If The U.S. Was A Corporation, Its Credit Rating Would Be Junk.” With $20.0 trillion of debt, $250.0 trillion in unfunded liabilities, and budget deficits as far as the eye can see, Wile. E. Coyote (America) is about to chase the roadrunner (debt) right off the fiscal cliff.

How Does the U.S. Stack Up against Other Nations?

In terms of credit rating quality, only a select few countries belong to the Triple-A club. Presently, this designation belong to Australia, Canada, Denmark, Germany, Liechtenstein, Luxembourg, Netherlands, Norway, Singapore, Sweden, and Switzerland. According to the agencies, there are six nations with negative outlooks for every nation with a positive outlook, so this list won’t get bigger anytime soon.

For the United States to climb back on top, S&P would need to reassert its Triple-A rating once adorned in 2011. But gaping budget deficits, massive unfunded liabilities, and proposed revenue-busting tax cuts will not help America’s rating prospects anytime soon. From this perspective, not ceding another inch, as in 2011, might be the best victory of all. But, most likely, the downgrades are coming sooner rather than later. If U.S. debt gets slashed below Double-A, and Treasury yields are forced higher, it’s game over.

We urge readers to prepare themselves accordingly.

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