U.S. Long-Term Credit Rating Outlook Revised to Negative by S&P on Deficit

Standard & Poor’s put the U.S. government on notice that it risks losing its AAA credit rating unless policy makers agree on a plan by 2013 to reduce budget deficits and the national debt.

“If an agreement is not reached and meaningful implementation does not begin by then, this would in our view render the U.S. fiscal profile meaningfully weaker than that of peer ‘AAA’ sovereigns,” New York-based S&P said today in a report that maintained its top rating on U.S. long-term debt while lowering the outlook to “negative” for the first time.

S&P said there’s a one-in-three chance that the rating might be cut within two years and that its “baseline assumption” is that Congress and the Obama administration will come to terms on a plan to reduce record deficits. Treasuries and the dollar rebounded from early losses following the statement, while stocks declined. Moody’s Investor Service, which has a stable outlook on U.S. debt, today said the U.S. budget debate is “positive” for the country’s credit.

“For most investors there is nowhere else to put their money as the U.S. still has the strongest, deepest, most-liquid markets in the world,” said Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd. “There is no alternative.”

The benchmark 10-year Treasury note yield was 3.37 percent at 2:19 p.m. in New York after rising as high as 3.45 percent. The Standard & Poor’s 500 index fell 1.4 percent to 1,301.41. The cost to protect against a default by the government and the nation’s banks rose.

Europe’s Woes

Sovereign credit quality has gained prominence as European countries from Greece to Portugal struggle to finance their debt. The Group of 20 nations named the U.S. as one of seven large economies that will face deeper scrutiny so their politics don’t derail a global expansion.

Overseas investors hold about half of the roughly $9 trillion in outstanding U.S. debt, including $1.2 trillion held by China. Treasury Secretary Timothy F. Geithner has said the U.S. shouldn’t be “borrowing from the Chinese” and other foreign investors to finance tax cuts for the wealthiest Americans.

Maintaining investor confidence overseas will be a question of political credibility rather than solvency for the U.S., said Lena Komileva, global head of G10 strategy at Brown Brothers Harriman & Co in London.

Lagging Behind

“In the relative universe of sovereign credits, investors are likely to view that the current episode of U.S. actions lagging behind market expectations as transitory which will keep U.S. risk premia contained,” Komileva said. “The euro remains the epicenter of global systemic risk.”

The Treasury said S&P’s outlook “underestimates” U.S. leadership, while Republicans tied the outlook change to the current fight over when and how to raise the debt ceiling. The Treasury says the $14.29 trillion limit will be reached no later than May 16, at which point the department will turn to emergency measures that provide borrowing room through about July 8.

S&P didn’t mention the debt ceiling among the budgetary risks it sees that affect the U.S. outlook, and it noted that the U.S. has “unique external flexibility” because the dollar is the world’s most-used currency. The ratings company focused on the political calendar, saying that if current negotiations fail, it might not be possible to get an agreement until at least the 2014 budget cycle.

‘Material Risk’

“We believe there is a material risk that U.S. policy makers might not reach an agreement on how to address medium- and long-term budgetary challenges by 2013,” S&P said in its statement.

Moody’s Investor Service said today that the U.S. budget debate is a positive development as Republicans and Democrats focus on the issue.

“While the politics surrounding an agreement remain contentious, we believe these two proposals together represent a significant shift in the U.S. fiscal debate, as both would result in lower deficits and debt levels,” Moody’s, which has a Aaa stable rating for the U.S., said in a report today.

President Barack Obama has proposed cutting $4 trillion in cumulative deficits within 12 years through a combination of spending cuts and tax increases. The administration is resisting Republican calls for swifter cuts, while also pushing for a set of rules to enforce spending reductions over time.

Austan Goolsbee, Obama’s chief economic adviser, rejected the S&P’s negative outlook, calling it a “political judgment” that he said doesn’t deserve “too much weight.”

‘Political Judgment’

“They are saying their political judgment is that over the next two years they didn’t see a political agreement” to reduce long-term deficits, Goolsbee, chairman of the Council of Economic Advisers, told Bloomberg Television’s InBusiness with Margaret Brennan. “I don’t think that the S&P’s political judgment is right.”

Goolsbee said Obama and Republican congressional leaders are “pretty close” in the deficit reduction targets they have announced. Each has set a target of $4 trillion, though House Republicans have a timeline of 10 years and the White House proposal would cumulatively cut that amount over 12 years.

House Majority Leader Eric Cantor called the S&P warning “a wake-up call for those in Washington asking Congress to blindly increase the debt limit.”

S&P’s negative outlook “makes clear that the debt-limit increase proposed by the Obama administration must be accompanied by meaningful fiscal reforms that immediately reduce federal spending and stop our nation from digging itself further into debt,” the Virginia Republican said in a statement.

To contact the reporters on this story: Shannon D. Harrington in New York at sharrington6@bloomberg.net; Cordell Eddings in New York at ceddings@bloomberg.net

To contact the editors responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net; Dave Liedtka at dliedtka@bloomberg.net

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