DBRS Confirms United States at AAA, Stable Trend

DBRS, Inc. has confirmed the AAA long-term foreign and local currency issuer ratings, and the R-1 (high) short-term foreign and local currency issuer ratings of the United States of America. All ratings are Stable.

The AAA ratings reflect the country’s unequalled financing flexibility as the issuer of the world’s benchmark asset and its reserve currency. Both features facilitate low financing costs and grant the U.S. Treasury a high capacity to service debt, even during periods of investor risk aversion and current expectations of higher interest rates. Strong economic institutions and a highly productive economy further bolster the ratings.

The Stable trend reflects a greatly improved macroeconomic outlook given a strong U.S. recovery in conjunction with a sharp reduction in the fiscal deficit. These factors have stabilized public debt to GDP ratios. Central (federal) government debt is likely to peak at 74.2% of GDP in 2015 and stabilize through the end of the decade. The broader general government debt to GDP ratio, which includes state and local government debt, is expected to stabilize this year at 105.1%.

The ratings could come under downward pressure over the medium term in the continued absence of a fiscal plan that aligns entitlement spending with revenues. A protracted deterioration in the credibility of macroeconomic policymaking that reduces the country’s financing flexibility and diminishes its debt tolerance could prompt a negative rating action.

Large, dynamic, and technologically advanced, the U.S. economy is undergoing a broad recovery – albeit slower than the 3.1% average growth performance in the two decades prior to the crisis. Supported by steady private sector activity and labor market improvements, the economy overcame early 2014 sluggishness to grow by 2.4% last year. DBRS expects growth to remain above potential output, in the range of 2.5%-3.0% in 2015 and 2016, due to remaining economic slack, still accommodative monetary policy, and lower fiscal drag than in fiscal years 2011-2014. The recent decline in oil prices should benefit the consumer, while technological advances in shale hydraulic fracking have led to an abundant supply of cheap oil and gas, improving prospects for consumers, manufacturers, and exporters through lower energy prices and enhanced energy efficiency.

The decline in the price of oil and the appreciation of the U.S. dollar are likely to have offsetting economic effects. The 52% fall in the international price of oil between June 2014 and March 2015 serves as a boost to household purchasing power. Adjusting for the expected decline in investments directed toward resource exploration, a net positive gain of around 0.3% to the U.S. economy in 2015 is possible due to the oil shock. Conversely, the roughly 14% trade-weighted appreciation of the dollar against a basket of major currencies over the same period has begun to weigh on manufacturing exports. The extent that currency depreciation and improved growth performance abroad benefit the U.S. economy through spillback channels remains unclear.

The large fiscal correction since 2009 further supports the ratings and reflects the flexibility of public finances. Although the fiscal adjustment imposed austere cuts on important spending programs, it succeeded in reducing the federal government deficit from 9.8% of GDP in 2009 to 2.8% of GDP in 2014. This decline was partly a result of sequestration, or automatic discretionary spending cuts triggered in early 2013 when Congress failed to agree on an alternative deficit reduction plan. Current congressional budget debates center around how best to roll back the more punitive elements of sequestration, while driving towards a long-run budget balance. Under current assumptions, the deficit will remain slightly below 3% of GDP in 2015 and 2016. Benefits from the preeminence of the U.S. dollar as the world’s primary reserve currency facilitates generally low financing costs and funding flexibility, and gives the U.S. Treasury a high capacity to service debt.

However, the medium-term fiscal pressures associated with an aging population and rising healthcare costs are significant. The CBO estimates that by 2025 mandatory outlays to the pension and healthcare systems will account for 56.6% of federal expenditures, from 50.1% in 2014. Mandatory spending is forecasted to reach 14.1% of GDP by 2025, compared to the 50-year average of 9.3%. If left unaddressed, these entitlement costs are likely to place upward pressure on public debt – estimated to increase to 77.1% of GDP in 2025 – and adversely impact long-term growth prospects by squeezing discretionary spending.

Despite real economic improvements in recent years, low labor participation rates and stagnant wage growth point to remaining cyclical and structural economic weaknesses. The 5.5% headline unemployment rate, down from nearly 10% in 2009, does not fully capture the underused resources in the economy. Labor participation declined from a peak of 67% in 2000 to the current level of 62.8%, explained by the overhang of dislocated labor from the economic recession and structural demographic change. Roughly four million workers retire each year, representing a structural shift to lower rates of labor participation. As economic slack tightens to generate greater demand for workers, cyclical labor market effects could reverse to pressure more robust wage growth. Annualized weekly wage growth averaged only 0.3% from 2007 to 2014.

Normalization of monetary policy could trigger some financial market volatility. The Federal Reserve has communicated it will only increase the federal funds rate when it sees “further improvements in the labor market and is reasonably confident that inflation will move back towards its 2% objective over the medium term.” In order to limit market instability and maintain the economic recovery, the timing of the initial rate increase will depend on economic conditions. Nonetheless, transitioning from a long period of low interest rates and quantitative easing is without precedent. A premature rate increase could trigger strong capital inflows from less stable international financial markets abroad, further dollar appreciation, and lower economic activity.

The decline in political cooperation in recent decades is a challenge. Though the Republican Party won a strong congressional majority last year, renewed maneuvering over the federal borrowing limit is possible in 2015 or subsequent years. The Treasury reached the debt ceiling in March 2015 and with extraordinary measures, debt servicing can continue until the autumn months of this year. While it remains unclear whether partisan conditions will accompany an increase to the borrowing limit, DBRS’s base case is for the U.S. Congress to increase the debt ceiling in a timely manner that avoids casting uncertainty over the Treasury’s credit quality.

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, 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: Jason Graffam
Rating Committee Chair: Roger Lister
Initial Rating Date: 8 September 2011
Most Recent Rating Update: 22 April 2014

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