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U.S. Risks August Downgrade If No Deficit Progress, S&P Says

Standard & Poor’s reiterated that the U.S. may lose its AAA credit rating as soon as August as the risk of a default escalates amid political wrangling to lift the debt limit while cutting the budget deficit.

The rating may be lowered to the AA+ range with a negative outlook next month even if an agreement to raise the debt ceiling in time to avert a potential default without a “credible” plan to lower deficits, S&P said in a report. The New York-based ratings company reiterated today that the chance of a downgrade is 50 percent in the next three months, as outlined when it placed the rating on “CreditWatch” for a downgrade on July 14.

The stepped-up pressure from S&P comes as U.S. Senate Majority Leader Harry Reid said the U.S. House’s decision to be out of session this weekend presents “a bad picture” to Americans as an Aug. 2 deadline nears for possible default. House Speaker John Boehner, an Ohio Republican, noted that the House has passed a proposal that would slash spending while conditioning a $2.4 trillion increase in the debt ceiling on passage of a constitutional amendment to balance the budget and make it more difficult to raise taxes. President Barack Obama has said he’ll veto the bill.

“The proposals seem too grand to get anything permanent done within this timeframe,” Ray Remy, head of fixed income in New York at Daiwa Capital Markets America Inc., one of 20 primary dealers that trade directly with the Federal Reserve, said in a telephone interview. “On the surface it looks good, but a temporary raise in the ceiling is not good.”

‘Gang of Six’

Yields on benchmark 10-year notes climbed nine basis points, or 0.09 percentage point, to 3.2 percent at 2:12 p.m. in New York, according to Bloomberg Bond Trader prices. The 3.125 percent securities maturing in May 2021 dropped 25/32, or $7.81 per $1,000 face amount, to 101 27/32.

A bipartisan group of senators called the Gang of Six proposed a $3.7 trillion deficit-reduction plan that has been embraced by Obama. Some Republicans have endorsed it or signaled openness to considering it. Lawmakers are focusing talks on the so-called grand bargain as well as providing a short-term increase in the debt limit, according to Representative Steny Hoyer, a Democrat from Maryland.

The U.S. would be cut to SD, or selective default, if it missed a payment on its debt, S&P said again today in a report. The Treasury has said the government, which reached its $14.3 trillion borrowing limit on May 16, will run out of options to prevent a default on Aug. 2.

Ratings Warnings

Fitch Ratings reiterated July 18 that it would cut all defaulted Treasury securities that it ranks to B+ from AAA if the government’s misses a debt payment. Moody’s Investors Service on July 13 put the U.S. on review for downgrade, saying the rating would be cut to the Aa range after a default.

A deal to raise the U.S. debt limit in return for spending cuts and revenue increases that would be determined later may not persuade S&P to remove its negative outlook on the government’s AAA credit rating as the firm evaluates “the likelihood that an agreed plan will be implemented.”

Ten-year Treasury yields of 3.125 percent are less than the average of about 4.07 percent during the past decade.

Investors should be wary that lower yields may still mask a burgeoning crisis, Mohamed A. El-Erian, chief executive and co-chief investment officer at Pacific Investment Management Co, said during a radio interview on “Bloomberg Surveillance” with Tom Keene and Ken Prewitt.

‘Too Late’

“I heard that very same statement in the case of Greece,” El-Erian said. “I wouldn’t underestimate how technical factors tend to contain prices until it’s too late.”

Euro-area leaders are considering accepting a temporary Greek default and widening the scope of their rescue fund as they try to resolve the region’s 21-month sovereign debt crisis. Greece is being charged about 34 percent to borrow for two years, compared with 10 percent a year ago and 1.6 percent in 2009.

Short-term interest rates may increase about 50 basis points while “shoving the U.S. economy back into recession” if the government fails to boost the debt ceiling and agree on reducing the deficit, S&P said. The government has $59 billion of debt maturing Aug. 4 and Aug. 11, and has $62 billion due on Aug. 15, S&P said.

U.S. economic growth may be reduced by as much as 50 basis points and longer-term yields would rise by the same amount if the U.S. was cut one level to AA+, S&P said.

The cost of insuring Treasuries for five years with credit-default swaps fell 0.2 basis point to 53 basis points, according to data provider CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market.

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