U.S. Needs Lower Deficits to Avoid Downgrade, Moody’s Says

The U.S. budget package passed by Congress won’t reduce deficits enough to avoid a sovereign-rating downgrade, according to Moody’s Investors Service.

The ratio of government debt to gross domestic product will likely peak at about 80 percent in 2014 and may stay at about that level for the rest of the decade, New York-based Moody’s said today in a statement. The ratings company assigns the U.S. its top Aaa ranking and has a negative outlook on the grade, as does Fitch Ratings.

“Stabilization at this level would leave the government less able to deal with future pressures from entitlement spending or from unforeseen shocks,” Moody’s said. “Further measures that bring about a downward debt trajectory over the medium term are likely to be needed.”

Standard & Poor’s cut the U.S. rating one step to AA+ on Aug. 5, 2011, with a negative outlook. “We believe that this characterization still holds,” the ratings company said today.

Yields on 10-year Treasuries have fallen about 72 basis points, or 0.72 percentage point, since the downgrade and touched a record low 1.38 percent on July 25.

The U.S. Dollar Index has gained 7 percent in that span and the S&P 500 index of stocks has returned 21 percent. Global bond markets have moved in deference to rating changes by Moody’s and S&P about 47 percent of the time, according to data compiled by Bloomberg on more than 300 changes since 1974.

Credit Outlook

“The compromise doesn’t affect our view of the country’s credit outlook,” S&P, a unit of New York-based McGraw-Hill Cos., said in a statement. “Yesterday’s agreement does little to place the U.S.’s medium-term public finances on a more sustainable footing.”

The nation faces about 10 percent to 15 percent chance of recession in the next year, compared with a 15 percent to 20 percent probability before the agreement on taxes and spending was reached, S&P said.

The legislation passed by Congress averts income-tax increases for most Americans while taxing top-earners more, yet leaves unanswered longer-term questions for taming the federal debt. Republicans are planning to use the need to raise the nation’s $16.4 trillion debt ceiling to try to force President Barack Obama to accept cuts in entitlement programs, such as Medicare. Congress must act as early as mid-February to prevent a default.

“Although Moody’s believes that the debt limit will eventually be raised and that the risk of default on Treasury bonds is extremely low, this confluence of events adds uncertainty to the outcome of negotiations,” the ratings company said. “The debt trajectory resulting from this process is likely to determine whether the Aaa rating is returned to a stable outlook or downgraded.”

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