Sequester Won’t Spur U.S. AAA Rating Downgrade, Fitch Says

While triggering the U.S. spending cuts known as the sequester and a government shutdown won’t prompt a ratings downgrade, those outcomes “erode confidence” of achieving deficit reduction needed to sustain the nation’s top credit grade, according to Fitch Ratings.

If Congress doesn’t act before the March 1 deadline, federal spending will be reduced by $85 billion in the final seven months of the fiscal year ending Sept. 30 and by $1.2 trillion over the next nine years. Legislation passed last year, known as a continuing resolution, funds the government through March 27. Fitch has had a negative outlook on the U.S.’s AAA ranking since 2011.

“Fitch expects to resolve the negative outlook placed on the sovereign ratings of the U.S.” this year, the company said today in a report. “Further delay in reaching agreement on a credible medium-term deficit reduction plan would imply public debt reaching levels inconsistent with the U.S. retaining its AAA status despite its exceptional credit strengths.”

The U.S. must implement $1.6 trillion of deficit reduction through tax increases and spending cuts, beyond the budget changes in the sequestration, to stabilize federal debt at 76 percent of gross domestic product, Fitch said. The deficit would have to be reduced by about $3 trillion to put the nation’s debt-to-GDP ratio on a downward trajectory, the rating company said.

Debt Ceiling

“Elevated levels of public indebtedness render the economy and public finances vulnerable to adverse shocks,” Fitch said. “Stabilizing the rating would need to be underpinned by a reasonable degree of confidence that public debt will be placed on a downward path in the latter half of the decade.”

Congress suspended the U.S. debt ceiling until May 18. Failure to increase the limit “in a timely manner,” which Fitch said it doesn’t expect to happen, “would prompt a review and likely downgrade of the U.S. sovereign rating,” the company said.

The sequestration cuts, with half in defense expenditures and half from domestic spending, would amount to about 0.5 percent of the $16 trillion economy this year and slice growth in gross domestic product by 0.6 percent while costing 750,000 jobs, according to the non-partisan Congressional Budget Office.

U.S. Downgrade

The measure stems from the 2011 negotiations to raise the debt ceiling that led to the creation of the so-called supercommittee, charged with finding additional savings in the budget on top of those agreed to by Congress.

The group failed to reach an agreement, triggering $1.2 trillion of cuts during the next nine years.

Treasuries rallied after Standard & Poor’s stripped the U.S. of its top ranking on Aug. 5, 2011, with yields touching a record low 1.379 percent in July 2012. U.S. government debt gained 9.8 percent in 2011, the most in three years, according to Bank of America Merrill Lynch index data. S&P and Moody’s, which assigns the U.S. its top Aaa ranking, have negative outlooks on the America’s credit rating.

Yields on sovereign securities moved in the opposite direction from what ratings suggested in 53 percent of 32 upgrades, downgrades and changes in credit outlook last year, according to data compiled by Bloomberg published in December on Moody’s and S&P grades.

Investors ignored 56 percent of Moody’s rating and outlook changes and 50 percent of those by S&P. That’s worse than the longer-term average of 47 percent, based on more than 300 changes since 1974.

Before it's here, it's on the Bloomberg Terminal.