How the Debt Ceiling Debate Could Affect America’s Credit Rating

  • Moody’s sees approach assuring nation’s full faith and credit
  • Fitch says use of method would warrant review of top grade

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Ratings companies expect Treasury Secretary Steven Mnuchin will resort to prioritizing U.S. debt payments if Congress fails to raise his borrowing authority in time. Yet the firms are in stark disagreement over what that would mean for the nation’s credit.

Moody’s Investors Service said Thursday that if Treasury exhausts the measures it’s using to fund itself and turns to prioritizing debt service over other obligations, the U.S.’s top rating would be safe. On the other hand, Fitch Ratings said Wednesday that such a move might jeopardize the country’s AAA rank.

With two of the biggest judges of sovereign creditworthiness voicing diverging views about the fate of the nation’s sterling rating, the onus is on investors to decide. The debate is only gaining in urgency, with little more than a month before the “critical” deadline Mnuchin has laid out for addressing the debt limit. And the political brinkmanship continues to grow, stoked by President Donald Trump’s remarks this week on the prospect of a government shutdown.

“Prioritization would not affect our sovereign rating,” Sarah Carlson, a senior analyst at Moody’s, said in an interview. “It’s obviously not an ideal thing, but our rating speaks to the risk of default or loss on government debt. If there were some non-debt obligations paid later than they otherwise would, that’s not the same thing.”

‘Uncharted Territory’

Mnuchin has said prioritization of debt payments isn’t an option. But ratings firms still expect Treasury to use it, based on plans worked out by the department and the Federal Reserve during past debt-ceiling episodes.

Fitch is less sanguine about the approach.

“The issue is that prioritizing debt-service payments has never been done, so we’d be in uncharted territory,” Charles Seville, a senior director at Fitch, said Wednesday. “There are operational risks, and our broader concern would be if not meeting other commitments would be compatible with AAA status. It’s not that we’d see default as inevitable after the x-date.”

There are other signs angst is building. The cost to protect against a U.S. default over the next five years through credit-default swaps has jumped to about 26 basis points, from 20 basis points a month ago. That means it costs 26,000 euros ($31,000) annually to insure 10 million euros worth of Treasuries against default. The expense reached 64 basis points during the 2011 debt-limit episode.

The Treasury secretary has said Congress needs to act before Sept. 29, while some Wall Street analysts estimate the drop-dead date will come in October.

In the market for Treasury bills, anxiety has picked up. The rate on bills maturing Oct. 12 jumped on Thursday, in the largest intraday move since March, after Trump in a series of a tweets blamed the lack of a debt-cap resolution on Republican leaders in Congress.

Trump’s Threat

On Tuesday, he threatened to shut the government over funding for a border wall, which could complicate Congress’s job of raising the debt ceiling. Congress also needs to pass a spending measure to keep the government open after Sept. 30. In one potential scenario, GOP leaders could package the two measures together to get them to the president’s desk.

“We’re going to get the debt ceiling passed,” Mnuchin said Monday. “Everybody understands, this is not a Republican issue, this is not a Democrat issue. We need to be able to pay our debts.”

Market participants and credit arbiters say a plan that was secretly considered by the Obama administration when the country almost breached the debt limit in 2011 signals that prioritization is a likely option if needed in 2017.

In this approach, the government could prioritize payments to bondholders, the military and Social Security over other obligations, such as the salaries of some federal workers. In 2011, Congress reached a deal before the plan was tested. Yet the showdown led S&P Global Ratings to downgrade U.S. sovereign debt for the first time, to one level below the top.

S&P’s view on prioritization is lining up with Moody’s.

“We expect Congress to ultimately raise or suspend the debt ceiling, potentially with heated discussion,” Roberto Sifon-Arevalo, head of sovereign ratings in the Americas at S&P, said via email.

“If the debt ceiling is not raised in a timely way, we expect, at a AA+ level of confidence, that the government will take necessary measures to avoid default on the debt which our ratings address,” which would include prioritizing debt payments, he said.

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