DBRS Confirms United States of America at AAA

DBRS, Inc. (DBRS) has confirmed the United States of America’s long-term foreign and local currency issuer ratings at AAA and its short-term foreign and local currency issuer ratings at R-1 (high). The trend on all ratings remains Stable.

The AAA ratings reflect the unparalleled size and resilience of the U.S. economy and U.S. financial markets. The U.S. Treasury and Federal Reserve System manage the world’s primary reserve asset and currency, respectively, which facilitate low cost local currency borrowing at a broad range of maturities, even during periods of investor risk aversion.

The Stable trend reflects DBRS’ expectation that continued U.S. economic growth and broad policy continuity will preserve the United States’ financial flexibility, even if public debt continues to rise. Through 2020, the Congressional Budget Office (CBO) forecasts federal government debt held by the public to average 78% of GDP, and the broader general government debt to GDP ratio to remain steady at 106%. The new administration and Republican-controlled congress are considering a major tax overhaul, which may have significant economic and fiscal implications and could result in higher fiscal deficits in coming years. DBRS nonetheless expects political pressures to result in sustainable fiscal policies over the medium term.

The ratings are underpinned by several structural strengths. The U.S. economy is large, innovative, and highly diversified. Accounting for one quarter of global GDP as of end-2016, output growth is highly resilient and well insulated from external shocks. The 2008-09 recession was the deepest recession in the post-WWII era, resulting in a 4.2% decline from peak to trough, and the recovery took significantly longer than previous recessions. Nonetheless, recent growth performance has been sufficient to bring the unemployment rate back below its historic average and close to the assumed natural rate.

The U.S. benefits from high levels of productivity, reflected in one of the highest levels of output per hour worked among OECD countries. GDP per capita reached $57,294 last year. A highly competitive and world class system of higher education, combined with openness and accessibility to foreign students and high-skilled migrants, helps to fuel innovation and dynamism in the U.S. economy.

U.S. financial markets are similarly unrivaled in size, with a combined market capitalization of U.S. equity and bond markets equal to 3.5 times U.S. annual output as of 2016. The U.S. dollar remains the most widely traded currency and serves as the primary global reserve currency. Similarly, U.S. Treasury securities serve as the preeminent global reserve asset. This in turn helps to preserve an inexpensive and stable funding base for the U.S. government.

Notwithstanding these credit strengths, federal government debt has increased significantly in the wake of the 2008-09 financial crisis and recession. Federal debt held by the public reached 77.7% of GDP as of end-2016. On a general government basis, outstanding debt has reached 101% of GDP. The gradual fiscal consolidation achieved by the previous administration and congress appears to be on hold, with significant uncertainty as to the scope of reforms to taxes and federal health care spending. Cuts in some areas of discretionary spending appear likely to be offset by an increase in defense spending. Meanwhile, in the absence of entitlement reforms, medium-term spending pressures are expected to add an average of 0.1% to the federal deficit each year for the next decade (2018-27), and an average of 0.2% to the deficit each year in the decade thereafter (2028-37). Under current law, Congressional Budget Office projections show federal debt reaching 89% of GDP by 2027 and to rise more rapidly thereafter, adding to budget pressures due to rising interest costs.

U.S. growth has averaged 2.1% since 2010, compared to 3.3% in the decade prior to the financial crisis. Productivity growth has remained relatively low and some analysis suggests this could be a permanent slowdown, resulting in lower potential growth in coming decades. The IMF estimates potential growth has slowed to below 2%. A gradual decline in labor force participation since 2000 accelerated in the wake of the financial crisis, and remains near 40 year lows at 63% of the population 16 and over. Although DBRS believes the U.S. economy will remain broadly resilient, lower average growth could add to medium-term fiscal challenges.

Particularly in the context of these medium-term economic and fiscal challenges, DBRS views political polarization as a concern. Projected increases in fiscal deficits over the medium-term are driven largely by rising healthcare spending and demographics. Durable bipartisan compromises to limit costs, increase efficiency and promote more effective pooling of risks in the health system are likely to be necessary. Similarly, some combination of tax increases (favored by some liberal groups) and cuts to benefit formulas (favored by some fiscal conservatives and advocates of limited government) may be unavoidable to provide a reasonable level of retirement security for an aging population. The appetite for compromise nonetheless appears limited, with both parties frequently relying on party-line votes to achieve their reform priorities.

This political environment has also resulted in a less coherent fiscal framework. Annual budget and appropriations battles often continue well into the fiscal year, leaving government agencies less able to plan and manage human and other resources effectively. Brinksmanship over fiscal and other priorities has led to occasional government shutdowns. The U.S. debt ceiling imposes a hard ceiling on debt issuance without reflecting current tax and expenditure policies, effectively threatening government arrears or default unless amended in a timely fashion. Finally, fiscal policy priorities are influenced more by presidential term cycles than by economic cycles, often resulting in excessively loose fiscal policy during periods of strong growth and potentially ill-advised demands to tighten fiscal policy during downturns.

RATING DRIVERS

The ratings could come under downward pressure over the medium term if there is a significant deterioration in federal public finances that weakens policy credibility and reduces the country’s financing flexibility. A failure to monitor and contain systemic risks in the financial system could also have an impact on U.S. economic resilience and the federal government’s balance sheet, with potentially adverse implications for the rating.

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. These can be found at http://www.dbrs.com/about/methodologies.

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 considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This rating was not initiated at the request of the rated entity.

The rated entity or its related entities did participate in the rating process. DBRS did not have access to the accounts and other relevant internal documents of the rated entity or its related entities.

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: Thomas R. Torgerson, Senior Vice President, Sovereign Ratings Group
Rating Committee Chair: Alan Reid, Group Managing Director, Financial Institutions and Sovereign Group
Initial Rating Date: September 8, 2011
Last Rating Date: April 29, 2016

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