Fitch Affirms U.S. 'AAA' Rating; Outlook Stable

(Updated - April 12, 2016 2:00 PM EDT)

Fitch Ratings has affirmed the United States' long-term foreign and local currency Issuer Default Ratings (IDRs) at 'AAA' with a Stable Outlook. Fitch has also affirmed the issue ratings on the United States' senior unsecured bonds at 'AAA', the Country Ceiling at 'AAA', and the short-term foreign currency IDR at 'F1+'.

KEY RATING DRIVERS
The U.S.'s 'AAA' rating is underpinned by the sovereign's unparalleled financing flexibility as the issuer of the world's pre-eminent reserve currency and benchmark fixed-income asset and as home to the world's deepest and most liquid capital markets.

The deficit and debt outlook has deteriorated since Fitch's last review, although it remains well within the tolerance of the 'AAA' rating. The federal fiscal deficit will widen in the 2016 fiscal year for the first time since 2009, reaching 2.9% of GDP according to the Congressional Budget Office, up from 2.5% of GDP in 2015, the low point since the global financial crisis. As interest rates on government borrowing creep up and the deficit stops narrowing, Fitch expects a gradual rise in general government debt from 101% of GDP in 2016 (75% of GDP for federal debt held by the public) to over 107% of GDP over the next decade. This assumes real GDP growth averages 2% and a gradual rise in government borrowing costs.

No immediate fiscal consolidation is in prospect. Congress lifted near-term caps on spending and reached solutions to a number of recurrent fiscal issues in 2015, most importantly making permanent a set of tax-reducing measures or 'tax extenders' that had previously required annual congressional approval. But this came at the cost of higher deficits in the near term and uncertain pledges to narrow deficits in future years.

Congress passed a new Bipartisan Budget Act at the end of 2015 and lifted the debt ceiling until March 2017, passing a funding bill to avert a government shutdown. A return to regular budget order is unlikely in 2016, as neither the House budget drawn up by the Republican majority (which proposes an aggressive spending-driven consolidation) nor the President's budget (which combines higher revenues from taxes and lowering exemptions with modest spending consolidation) receive a reading in Congress.

Whatever the result of the congressional and presidential elections to be held in November, neither party is likely to win full control of both houses of Congress and the presidency, making progress on fiscal issues dependent on bipartisan cooperation. The most immediate fiscal challenge is to restore the social security system - largely unaddressed by 2016 budget proposals - to a more sustainable state. The main social security trust fund is projected by its trustees to run dry in 2029 as payments outpace contributions.

The U.S. economy grew 2.4% in 2015, a strong performance compared with most other advanced economies. Growth was undermined by a contraction in the oil industry and soft foreign demand, exacerbated by dollar strength. The domestic growth story is underpinned by consumer demand and steady labour market improvement, with unemployment falling to 5% in March 2016. However, with 1Q16 promising to be relatively weak, Fitch has revised down its real GDP growth forecast to 2.1% in 2016 and 2017, in line with estimates of long run potential growth, in an environment of slowing growth in the labour force and modest productivity gains.

The output gap is closing, and headline inflation is below the Fed's 2% target, with core CPI inflation already at 2%. Even if the Federal Reserve tolerates a temporary overshoot of current inflation, Fitch expects two more policy rate rises in 2016 and three in 2017, slightly above market expectations but in line with the Federal Reserve FOMC forecast.

The economy is large, rich and diverse, with GDP per capita (at purchasing power parity) and levels of human development above the 'AAA' median. The economy is one of the most productive, dynamic and technologically advanced in the world, underpinned by strong institutions and a favorable business climate.

The U.S. runs a current account deficit, which widened by 0.5pp of GDP to 2.7% of GDP in 2015, while the median 'AAA' sovereign runs a substantial surplus. However, the current account deficit is mirrored by capital inflows from foreign investors, including into sovereign assets. The sovereign, banks and the non-bank private sector alike are all net external debtors. The net external debt position of the U.S. is equivalent to 49% of GDP, a weakness relative to the 'AAA' median.

RATING SENSITIVITIES
The current Rating Outlook is Stable. Consequently, Fitch's sensitivity analysis does not currently anticipate developments with a material likelihood, individually or collectively, of leading to a downgrade. However, future developments that may, individually or collectively, lead to negative rating action include:

A significant increase in government deficits and debt/GDP ratio, for example if the U.S. authorities do not take measures in the medium to long term to offset rising expenditure pressures from aging and higher interest rates, could lead to a downgrade.

A deterioration in the coherence and credibility of economic policymaking or a negative shock that erodes the role of the U.S. dollar as the pre-eminent global reserve currency and reduces financing flexibility and debt tolerance could lead to a downgrade.

KEY ASSUMPTIONS

Fitch assumes that the federal debt limit, which will be re-imposed in March 2017, will be suspended again or raised in due course before the Treasury exhausts its extraordinary measures and capacity to fund the government.

Fitch's medium-term fiscal projections draw heavily upon Congressional Budget Office projections, which incorporate a baseline assumption that current laws governing federal taxes and spending generally remain the same. Fitch's projections also assume that the medium-term growth potential of the U.S. economy is 2%. Its projections are sensitive to these and other economic and fiscal assumptions.

Financial sector risks are currently judged to be low, as reflected in Fitch's stable outlook for the U.S. banking sector and Bank Systemic Indicator of 'a'.

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