DBRS Confirms the United States at AAA, Stable Trend

DBRS, Inc. has today confirmed the long-term foreign and local currency issuer ratings of the United States of America at AAA, and its short-term foreign and local currency issuer ratings at R-1 (high). A Stable trend has been assigned to all ratings. The ratings are no longer Under Review Negative.

DBRS placed the ratings Under Review on October 9, 2013 to reflect the risk of a selective default on federal government securities following the latest in a series of political standoffs over increases to the statutory limit on federal debt (the debt ceiling). Failure to lift the debt ceiling prior to an October 17, 2013 deadline would have impaired the Treasury’s ability to borrow and cover its obligations. A default was averted when the borrowing authority was temporarily suspended on October 16, 2013. Following this, early this year Congress passed a spending bill to fund the federal government and suspend the debt limit through March 15, 2015. Both passed without partisan conditions, which had been the main obstacle to previous agreements. Reduced tensions over the debt ceiling led to today’s removal of the Under Review designation.

Despite this improvement, uncertainty over future political cooperation remains, especially given congressional elections this November. Another political impasse over the budget and debt ceiling early next year remains a short term risk. Nevertheless, in the wake of the series of impasses already surmounted, DBRS considers a selective default to be unlikely given the repercussions on the political parties, on investor sentiment and on the economic recovery.

The Stable trend reflects a greatly improved macroeconomic outlook given strong U.S. growth prospects in conjunction with a sharp reduction in the fiscal deficit. Positive developments in the energy sector that could enhance competitiveness across a number of industries provide further uplift. These factors have stabilized public debt to GDP ratios. The Congressional Budget Office (CBO) expects central (federal) government debt to peak at 73.6% of GDP in 2014 and stabilize in the subsequent years. The International Monetary Fund (IMF) expects the general government debt to GDP ratio, which includes state and local government debt, to stabilize this year at 105.7%.

The ratings could come under downward pressure in the continued absence of a fiscal plan that aligns entitlement spending with revenues over the medium term. Another political impasse over the debt ceiling that significantly increases the likelihood of a selective default could prompt DBRS to return the ratings to Under Review.

The AAA ratings reflect the many underlying strengths of the United States. The world’s largest economy is highly productive, diversified and flexible. Almost seven years after the onset of the financial crisis, the economy has returned to solid growth. This improvement comes in spite of a strong fiscal consolidation which has served as a drag on activity. The IMF expects the economy to grow by 2.8% and 3.0% in 2014 and 2015, respectively. This above-trend growth will likely be driven by more moderate fiscal consolidation, accommodative monetary conditions, a recovery in the real estate market, rising household wealth, improved corporate balance sheets, and easier bank lending conditions.

Contributing to the favorable outlook are technological advances in shale oil and gas hydraulic fracking, which are likely to have significant positive effects on growth for years to come. Improvements in natural gas and oil extraction have increased oil and gas production. An abundant supply of cheap oil and gas improves prospects for consumers, manufacturers and exporters through lower energy prices and enhanced energy efficiency.

The ratings are further supported by the large fiscal correction over the last five years. Although the adjustment imposed austere cuts on important spending programs, it succeeded in reducing the deficit and reflects the flexibility of public finances. The central government deficit declined from 9.8% of GDP in 2009 to 4.1% of GDP in 2013. This decline was largely the result of sequestration, or automatic spending cuts triggered in early 2013 when Congress failed to agree on an alternative deficit reduction plan. The January 2014 spending bill rolled back some of the cuts. Nevertheless, the deficit is expected to decline to a manageable 2.8% and 2.6% of GDP in 2014 and 2015, respectively.

More than any other country, the United States enjoys the benefits from the preeminence of the U.S. dollar as the world’s primary reserve currency. This facilitates generally low financing costs and funding flexibility, and gives the U.S. Treasury a high capacity to service debt, even during periods of investor risk aversion and current expectations of higher interest rates.

Continued political cooperation is important to the ratings. The debt ceiling is designed to be the government’s principal debt-break instrument. However, it has proven ineffective at reinforcing counter-cyclical fiscal policy. The recent agreement to raise the debt ceiling through March 2015 eliminated the immediate risk of another standoff. However, the reasons for the impasse – a stark partisan divide over the role of government and how to fund it – may remain, and could continue to pose a challenge to normal budgetary procedures.

The medium-term fiscal pressures associated with an aging population and rising healthcare costs are significant. In 2013, mandatory outlays in Social Security, Medicare and Medicaid (the pension and healthcare systems) accounted for 45.6% of federal expenditures in 2013. The CBO estimates these costs will rise to 48.8% by 2024 unless policy changes alter this trajectory. The Medicare Board of Trustees calculates that social security costs will exceed non-interest income in every year of the Board’s 75 year projection, and that the Social Security Trust Fund reserves will be depleted by 2016. If left unaddressed, these entitlement costs will likely place upward pressure on the public debt to GDP ratio. The pace of debt accumulation has recently slowed, but the debt to GDP ratio is high. On its current path, central government debt will likely peak this year, stabilize through 2017, then starting in 2018 increase steadily.

Uneven employment dynamics present a further challenge. Despite stronger economic activity, job creation is weaker than previous recoveries. Greater employment gains are held back by both labor demand and labor supply. Weak growth in labor-intensive sectors, private sector deleveraging and higher efficiency gains in the corporate sector have reduced the demand for labor. On the supply side, higher-skilled jobs make up a large share of total employment. Yet, long-term structural imbalances persist in education, skills training, and income distribution, and these imbalances are slowing down the migration of workers toward higher skilled jobs. These factors have contributed to a slow recovery in the labor market and a large share of long-term unemployment. In 2013, workers unemployed for over 27 weeks represented 38% of the unemployed, compared to 17% in 2006. The long-term unemployed appear to be contributing to a decline in the labor participation rate.

The normalization of monetary policy is important for financial stability and the strength of the economic recovery. Since the onset of the financial crisis, the Federal Reserve has adopted an accommodative policy stance by maintaining low interest rates and purchasing U.S. Treasury securities and mortgage backed securities. This appears to have contributed to the stabilization of the financial sector, and is supporting the housing market and the recovery. As the economy strengthens, the Fed has begun to slow the pace of asset purchases. This presents a dual challenge. There is a risk that the Fed could impair the recovery if it reduces its asset purchases too quickly or allows long-term interest rates to rise prematurely. A second risk is the financial vulnerabilities stemming from a prolonged period of low interest rates. Investors taking on credit or duration risks as they search for higher yields, or corporates that have increased their leverage, could be exposed to a large or unexpected rise in market interest rates. This could affect financial stability.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The principal applicable methodology is Rating Sovereign Governments, which can be found on the DBRS website under Methodologies. The principal applicable rating policies are Commercial Paper and Short-Term Debt, and Short-Term and Long-Term Rating Relationships, which can be found on our website under Rating Scales.

The sources of information used for this rating are the U.S. Treasury, the Congressional Budget Office, Federal Reserve, Office of Management and Budget, Bureau of Economic Analysis, Bureau of Labor Statistics, International Monetary Fund, World Bank, DBRS. DBRS considers the information available to it for the purposes of providing these ratings was of satisfactory quality.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

For further information on DBRS’ historic default rates published by the European Securities and Markets Administration (“ESMA”) in a central repository see http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period while reviews are generally resolved within 90 days. DBRS’s trends and ratings are under constant surveillance.

Lead Analyst: Fergus McCormick
Rating Committee Chair: Roger Lister
Initial Rating Date: 8 September 2011
Most Recent Rating Update: 9 October 2013

For additional information on this rating, please refer to the linking document under Related Research.