S&P Affirms United States AA+ Rating; Outlook Stable

(Updated - June 10, 2015 5:55 PM EDT)

S&P Affirms United States AA+ Rating; Outlook Stable:

From the Release:

OVERVIEW

• Credit strengths of the U.S. include its diversified and resilient economy, its extensive economic policy flexibility, and its unique status as the issuer of the world's leading reserve currency.
• However, a high level of general government debt as well as a lack of political cohesion among the main parties in Congress--resulting in comparatively short-term oriented policymaking--constrain the ratings. Although the debt burden is projected to have stabilized, it will likely rise toward the end of the decade absent medium-term measures to raise additional revenue and/or cut nondiscretionary expenditure.
• We are affirming our 'AA+/A-1+' sovereign credit ratings on the U.S.
• The outlook remains stable, reflecting our view that there is less than a one-in-three chance that we will change the rating in the next two years based on our expectation that the inherent economic and policy strengths of the U.S. will continue to be juxtaposed against an absence of political cohesion.

RATING ACTION

On June 10, 2015, Standard & Poor's Ratings Services affirmed its 'AA+' long-term and 'A-1+' short-term unsolicited sovereign credit ratings on the United States of America. The outlook on the long-term rating remains stable.

RATIONALE

The sovereign credit ratings on the U.S. are supported by the resiliency and diversity of its economy, its institutional strengths, its extensive economic policy flexibility (including its management through the 2008-2009 global financial crisis, particularly its proactive monetary policy), and its unique status as the issuer of the world's leading reserve currency. A lack of political cohesion in recent years among the main parties in Congress--complicating the policy decision-making process and resulting in a somewhat weaker ability to enact reform--constrains the ratings. The general government debt burden (as a share of GDP) has doubled since 2007. Although the general government debt burden is projected to hold steady over the next several years, we expect it to rise toward the end of the decade absent measures to raise additional revenue and/or cut nondiscretionary expenditure. In addition, contingent liabilities associated with the nonbank financial sector, namely from the government-sponsored enterprises Fannie Mae and Freddie Mac, contribute to the burden on public finances.

With a per capita GDP of US$56,000 for 2015, the U.S. ranks 11th out of the 129 sovereigns that Standard & Poor's rates in terms of income level (see the interactive version of Sovereign Risk Indicators, at spratings.com/SRI). The breadth and depth of the U.S. economy, coupled with a track record of proactive policymaking at the depth of the recession, underpin the recovery since that time. The level of real GDP is 13% higher than its low point in second-quarter 2009. Although the recovery has been subpar compared with previous rebounds, it followed the most severe economic downturn since 1929. The pace of the U.S. rebound also compares favorably with other advanced economies. Long-term potential growth is likely to be close to 2% a year, reflecting aging demographics (which contribute to labor force participation being at a 36-year low) and diminished labor productivity gains over the past decade compared with the postwar average.

We expect growth of 2.4% this year, similar to 2014, after a contraction in the first quarter of 2015, owing mostly to temporary factors. Over the next several years, we expect real GDP growth of just below 3%. This growth rate is supported by ongoing improvement in the labor market, with steady job gains putting unemployment at 5.5% in May (near its lowest point since the recovery began), and in the housing sector. Despite the decline in shale energy investment caused by lower global oil prices, we expect continued revival in manufacturing because of competitive labor costs and the lower cost of natural gas stemming from increased shale gas production. In addition, deleveraging in the U.S.'s household sector is more advanced than it is for European sovereigns, and the U.S. banking system has bolstered its financial strength more through raising capital than deleveraging. Moderation in fiscal drag at the federal, state, and local government levels (together, the general government) last year and in the near term also supports growth. As economic and labor market conditions have improved, the Federal Reserve has begun a slow process of normalizing monetary policy.

In October 2014, the Federal Reserve announced that it concluded its large-scale asset purchase program, setting the stage for increases in the federal funds rate for the first time since 2006, once economic conditions warrant a tightening of monetary policy. In line with signals from the authorities, we expect slow and measured increases in the overnight rate given lingering constraints on household income following the financial crisis. Long-term unemployment, though down, remains higher than prerecession levels. Wage growth has been modest for most households.

The U.S.'s policymaking and political institutions tend to be transparent and accountable. The checks and balances of the U.S.'s system of government have generally generated a stable backdrop for economic prosperity and the free flow of information, notwithstanding the recent budgetary impasses. Unparalleled economic data in terms of timeliness and coverage are readily and publicly available. A strong civic society, political stability, respect for property rights and the rule of law, and success as a driver of innovation have supported economic prosperity and underpin the U.S. dollar's status as the world's premier reserve currency.

This reserve currency status affords the U.S. significant flexibility in its external accounts. Taking into account the key reserve currency status, as well as the degree to which the U.S. has supplied liquidity around the globe in recent years, our political and economic analysis suggests that the U.S. has unparalleled external liquidity. The external analysis is complicated by the dominant reserve currency role. Whereas the ratio of external debt, net of liquid assets, averaging about 335% of current account receipts (CAR) during 2015-2018, is high compared with the ratios of most sovereigns, the overall net external liability position of the U.S. is lower. In addition, the debtor position may be overstated, considering currency issues, composition considerations, and the difficulty of recording multinational activity of U.S. private companies in offshore centers.

Valuation effects on the U.S.'s external assets and liabilities, including derivatives, dominate the external stocks vis-à-vis the balance-of-payments cash flows. The current account deficit declined to 2.4% of GDP in 2013 and remained at that level last year, from a prerecession 2006 peak of 5.8% of GDP, and we expect it to remain around this level. Prospects for ongoing shale gas and oil production could turn the U.S. from a net energy importer to potentially a net energy exporter. In October 2013, domestic production of crude oil was higher than imports for the first time since 1995. The significant increase in natural gas production--with the U.S. the largest natural gas producer in the world--will support natural gas exports.

At the outset of the 2008-2009 recession, the Federal Reserve acted promptly and innovatively to stanch the collapse in credit. It provided exceptional support to broker-dealers, commercial paper issuers, mutual funds, large insurance companies, U.S. offices of foreign banks, and foreign central banks, to name a few. These operations have since been wound down. At the same time, the Fed has supported monetary conditions through balance sheet expansion, having reached the zero bound in interest rates in 2008. The Fed's holdings of government securities and mortgage-backed securities totaled $4.2 trillion (24% of GDP) at the end of April 2015, holding steady since the decision to end long-term asset purchases in October 2014, and up from $741 billion in December 2007 (5% of GDP). We expect that the Fed will likely begin to rein in its balance sheet only after it has begun to raise the federal funds rate (which could be in the third quarter of 2015). In preparation for this normalization, the Fed has developed its tools to manage the process, including paying interest on bank reserves and expanding the list of eligible counterparties for reverse repurchase transactions. We believe inflation expectations are well-anchored, as evidenced by the yields on 10-year TIPS (government inflation-linked notes).

The stability and predictability of U.S. policymaking and political institutions, although high, have weakened somewhat from the time we rated the U.S. 'AAA', in our view. We find that a series of political impasses has impeded more effective policymaking compared with some highly rated advanced sovereigns. An example is the vigorous debates in October 2013 about raising the debt ceiling and shutting down the government. As expected, a last-minute compromise was struck, but we view the continued shorter-term nature of political fiscal calculations and deal-making to be negative credit factors.

That said, a series of agreements have been struck. Both parties reached across the aisle to avoid the so-called "fiscal cliff" in December 2012 and passed the American Taxpayer Relief Act (ATRA2012), making permanent some expiring tax cuts and allowing high-income tax cuts to expire. Following vigorous debate over shutdown of certain governmental functions and over the debt ceiling in October 2013, both parties concluded The Bipartisan Budget Agreement (BBA2013) in December 2013. BBA2013 provided partial relief from the automatic sequestration of discretionary spending in fiscal 2014 and fiscal 2015 (by a combination of higher revenues, spending reductions, and extending sequestration beyond its previous end date by an additional two years). BBA2013's agreement on overall discretionary spending levels facilitated subsequent funding appropriation discussions for both fiscal years.

Fiscal decisions that will require bipartisan efforts later this year include funding the budget for fiscal 2016, which will entail reconciliation of the budget resolution adopted by the Republican led-Congress and the administration's budget proposal. Similarly, Congress will soon find itself in a position of having either to vote for an increase in the debt ceiling or suspend it for some period of time (which has been the recent modus operandi). Suspension of the debt ceiling expired in March 2015, and the Treasury is undertaking extraordinary measures in order to stay below the debt ceiling. Although we expect the discussions about the debt ceiling to be ultimately resolved as they have been, it has been our long-held view that debate poses a risk to the economy.

Additional signs of cross-party dialogue on these pertinent fiscal issues could support the U.S. sovereign credit rating. Bipartisan successes in 2015 include passage of a Medicare finance bill (that repeals long-standing caps on Medicare payments to doctors that were annually and temporarily suspended) and potential approval of fast-track trade promotion authority. On the other hand, efforts to extend highway trust funding and the charter of Export-Import Bank have been less successful thus far.

More ambitious steps to stem rising medium-term fiscal pressures do not appear to be in the offing. Although both parties agree on the need to lower the government debt burden, the parties' positions about how this might be achieved are far apart. In the run-up to the presidential elections in 2016, we do not expect entitlement or tax reform to advance. Although both leading Democrats and Republicans appear to have strong interest, in principle, in tax reform, our base case is that reform would not advance until a new administration takes office.

Against this backdrop, we see that there has been some improvement in the fiscal position of the U.S. Fiscal deficits have declined since 2009. The improvement is part cyclical and part structural following from policy decisions--namely implementation of the Budget Control Act of 2011 (BCA2011), ATRA2012, and BBA2013.

Under our criteria, our primary fiscal metric on the flow side is the change in general government debt. The change in debt results mostly from yearly deficits, but also from off-budget activities, such as net lending. The general government deficit (as stated in the National Income and Product Accounts on a calendar-year basis) has declined by more than by half, to 4.7% of GDP in 2014 from 12% in 2009. Most of this improvement stems from the federal government, due to cyclical improvements in revenue, the rescinding of the temporary reduction in social security contributions, higher tax rates on high-income earners, and expenditure restraint as a result of caps imposed by BCA2011. The change in general government debt also includes such items as the increase in direct student loans (that has averaged about 0.7% of GDP a year).

While deficits have declined, net general government debt to GDP remains high at about 80% of GDP. Given our growth forecasts and our expectations that credit conditions will remain subdued, thus keeping real interest rates in check, we expect this ratio will remain stable through 2018, at which point it will likely begin to again deteriorate. In addition, our assessment of the U.S.'s debt position incorporates our view that contingent liabilities from the financial sector and all nonfinancial public enterprises are moderate. The moderate assessment is driven primarily by the materiality and systemic importance of Fannie Mae and Freddie Mac in light of their low levels of capitalization. In our view, the credit standing of both entities incorporates our assessment of an almost certain likelihood of extraordinary support from the U.S. Treasury given their critical policy role in the housing sector and integral link with the government. With $5.2 trillion in assets as of December 2014, they are material in size: 30% of GDP and equivalent to about 40% of the total assets for depository institutions assets and about 20% of nondepository institutions assets.

OUTLOOK

The stable outlook incorporates our view that there is less than a one-in-three likelihood that we will change the ratings over the next two years. We do not see material risks to our favorable view of the flexibility and efficacy of monetary policy. We believe U.S. economic performance will match or exceed that of most other advanced economies in the coming years.

The 'AA+' rating already factors in our view that U.S. elected officials are less able to react swiftly and effectively to public finance pressures than are officials of some more highly rated sovereigns. It includes the prospect that debates over raising the debt ceiling could be protracted and difficult. We expect these debates to conclude without provoking a sharp discontinuous cut in expenditure or in debt service. However, under our criteria, certain measures taken as a consequence of a debt ceiling impasse could amount to a default. One example of such a measure might be the U.S. government unilaterally extending the payment maturities of its sovereign obligations, even if for short periods.

We see some risk that continued improvement in economic performance could lead to complacency in addressing the U.S.'s medium-term fiscal challenges. Less likely than complacency, but more consequential for the rating, would be a deliberate relaxation of fiscal policy without countervailing measures to address the U.S.'s longer-term fiscal challenges, which, if serious enough, could lead to a downgrade. We could raise the rating to 'AAA' if we see evidence of successful bipartisan efforts around fiscal policy decisions, or a pronounced decline in the general government debt burden. Constructive debate and consequent budget legislation over addressing discretionary spending and the debt ceiling later this year might be examples of such evidence. A lower debt burden could result from implementation of bolder medium-term fiscal policy measures or a more robust growth trajectory.

KEY STATISTICS

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RATINGS SCORE SNAPSHOT

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