S&P Affirm's U.S. AA+/A-1+ Ratings; Outlook Stable

• The credit strengths of the U.S. include its diversified and resilient economy, extensive economic policy flexibility, and unique status as the issuer of the world's leading reserve currency.
• However, high general government debt, relatively short-term-oriented policymaking, and uncertainty about policy formulation constrain the ratings.
• We are affirming our 'AA+/A-1+' sovereign credit ratings on the U.S.
• The outlook remains stable, reflecting our expectation that long-standing institutional strengths and robust checks and balances will support policy execution and that the inherent economic strengths of the U.S. will continue to offset the government's high level of debt.

RATING ACTION

On June 6, 2017, S&P Global Ratings 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. The T&C assessment is unchanged at 'AAA'.

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. Disagreement across and within political parties has resulted, in our view, in slower decision-making and has limited the government's ability to enact forward-looking legislation. These factors, along with the government's high level of debt, constrain the ratings.

Some of the Administration's policy proposals appear at odds with policies of the traditional Republican leadership and historical base. That, coupled with lack of cohesion, not just across, but within parties, complicates the ability to effectively and proactively advance legislation in Congress, particularly on fiscal policy. Taken together, we don't expect a meaningful expansion or reduction of the fiscal deficit over the forecast period.

The U.S.'s net general government debt burden (as a share of GDP) remains twice its 2007 level. While, in our view, debt to GDP should hold fairly steady over the next several years, we expect it to rise thereafter absent measures to raise additional revenue and/or cut nondiscretionary expenditures. In addition, the contingent liabilities associated with the nonbank financial sector, namely the government-sponsored enterprises Fannie Mae and Freddie Mac, contribute to the burden on public finances.

With per capita GDP of over US$59,000 for 2017, the U.S.'s income level is 10th out of the 131 sovereigns that we rate (see the interactive version of "Sovereign Risk Indicators" at www.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 then. 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 that of other advanced economies. That said, long-term potential growth in the U.S. has declined and will likely be close to 2%, reflecting aging demographics (which contribute to labor force participation being near a 40-year low) and diminished labor productivity gains over the past decade compared with the postwar average. This underscores a challenge for policymakers in the U.S. in the coming years.

We expect growth of about 2.3% this year following 1.6% growth in 2016. During 2018-2019, we expect real GDP growth to average 2.2%. This growth rate is supported by consumers, with ongoing improvement in both the housing sector and the labor market. The decline in shale energy investment stemming from lower global oil prices weighed on investment in 2016, but this shows signs of reversing. Firming of prices more recently and approval of the Keystone Pipeline should support growth in the energy sector. In addition, we expect continued gains in manufacturing because of competitive labor costs and the lower cost of natural gas stemming from increased shale gas production. We also assume budgetary sequestration will not go into effect in fiscal-year 2018.

As economic and labor market conditions have improved, the Federal Reserve has begun a slow process of normalizing monetary policy. In March 2017, the Federal Reserve raised the federal funds rate to 0.75%-1.00%. We expect slow and measured increases in the overnight rate as decisions remain data driven. In line with the Fed's signaling, we expect it to start to reduce the size of its balance sheet by year-end. Its holdings of government securities and mortgage-backed securities totaled $4.3 trillion (23% of GDP) at the end of February 2017, remaining 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 provide further guidance on how it plans to reduce its balance sheet later this year.

Policymaking and political institutions in the U.S. tend to be transparent and accountable. The checks and balances of the system of government have generally generated a stable backdrop for economic prosperity and the free flow of information, notwithstanding several budgetary impasses in recent years. 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 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, 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. We expect the ratio of external debt, net of liquid assets, to average 377% of current account receipts during 2017-2019, which is high compared with the ratios of most sovereigns. However, the overall net external liability position of the U.S. is lower. In addition, the external 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 current account cash flows. The current account deficit was 2.6% of GDP in 2016, and we expect it to rise to about 3.4% in 2019. That would still be below a prerecession 2006 peak of 5.8% of GDP but is up from the recent low of 2.2% in 2013.

In our view, the stability and predictability of U.S. policymaking and political institutions are high. However, disagreement across and within political parties complicates passage of forward-looking fiscal legislation compared with other highly rated advanced sovereigns. Ambitious steps to stem rising medium-term fiscal pressures remain politically challenging. Given that tax reform is a policy priority for the Administration and Congressional Republican leadership, we do expect a modest tax package will be passed. However, we believe, at present, that prospects are more remote for deeper fiscal reform.

The government faces an upcoming deadline for negotiating an agreement to suspend the debt ceiling. The last suspension expired on March 15, 2017. The Treasury declared a debt issuance suspension period and has been undertaking extraordinary measures to stay below the debt ceiling. We expect Congress to ultimately raise or suspend the debt ceiling, potentially with heated discussion. It remains our view that the ensuing debate about raising or suspending the ceiling weighs on the economy.

Improvement in the U.S.'s fiscal position reflects lower deficits since 2009. The decline is part cyclical and part structural, following from policy decisions. 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 half--to 4.4% of GDP in 2016 from 12.1% in 2009. Most of this improvement stems from the federal government. We expect the general government deficit to average 4.2% of GDP during 2017-2020, and we assume Congress will pass some form of a budget agreement later this year, lifting sequestration for 2018 (and potentially 2019), similar to what was done in the Bipartisan Budget Agreements of 2013 and 2015. Both provided partial relief from the automatic sequestration of discretionary spending by a combination of higher revenues, spending reductions, and extending sequestration until 2025. The change in general government debt also includes items such as the increase in direct student loans (that has averaged about 0.6% of GDP a year).

Although 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 to hold fairly steady through 2020. At that point, it could deteriorate more sharply, partly as a result of demographic trends.

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. This assessment stems primarily from the materiality and systemic importance of Fannie Mae and Freddie Mac in light of their low capitalization. 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 $5.3 trillion in assets as of March 2017, they are material in size--almost 30% of GDP and equivalent to about 30% of the total assets for depository institution.

OUTLOOK The stable outlook signals our view that negative and positive rating factors will be balanced over the next two years.

The 'AA+' rating already factors in our view that political divisions will continue to weigh on the government's ability to address public finance pressures in a more timely manner. We expect that debates over funding the government and raising the debt ceiling will be resolved at the ultimate moment, as they have been in recent years. We also expect the U.S.'s institutional checks and balances to contribute to stability and predictability in economic policies. A meaningful relaxation of fiscal policy, without countervailing measures to address the longer-term fiscal challenges of the U.S., could lead to a negative rating action.

On the other hand, we could raise the rating if we see signs of more effective and proactive public policymaking, which could reflect greater cohesion between the Executive and Congress than what we have seen in recent years.

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