DBRS Morningstar Confirms United States at AAA, Stable Trend

DBRS, Inc. (DBRS Morningstar) confirmed the United States of America’s Long-Term Foreign and Local Currency – Issuer Ratings at AAA. At the same time, DBRS Morningstar confirmed the Short-term Foreign and Local Currency – Issuer Ratings at R-1 (high). The trend on all ratings is Stable.

KEY RATING CONSIDERATIONS

The Stable trend reflects DBRS Morningstar’s view that the strength of the U.S. economy, institutions and financial markets will continue to provide support to the rating. The U.S. economy is slowing, though it continues to outperform other major advanced economies. Risks to the economy are tilted to the downside: an expansion of tariffs on Chinese goods or other domestic shocks could exacerbate the ongoing slowdown. DBRS Morningstar does not expect an outright recession, but a broadening of the trade war to include key industries (e.g., autos) across multiple trading partners (e.g., Canada, Mexico, the EU or Japan) would likely have adverse confidence effects and could tilt the economy into recession. With household and corporate balance sheets in relatively good condition, a downturn is likely to be short-lived unless compounded by policy errors.

U.S. fiscal balances are expected to deteriorate over coming years due to demographic trends and as near term expenditure priorities take precedence over long-term worries over rising federal debt. With long-term interest rates near record lows, the federal government has additional time to reduce the federal budget deficit without generating downward pressure on the U.S. sovereign rating. However, DBRS Morningstar remains concerned over the medium-term trajectory of federal debt held by the public. Rising debt creates two problems. One, it increases the frequency with which Congress must act to raise the debt ceiling, with individual political parties often linking the debt ceiling to other policy debates and increasing the risk of nonpayment if a compromise is not reached in a timely manner. And two, over the medium-term, a heavier debt burden will make it more difficult for the U.S. to manage the fiscal pressures associated with an aging population.

RATING DRIVERS

Near-term pressure on the U.S. rating appears unlikely. However, a failure to reduce projected deficits over the medium-term could limit fiscal flexibility in future downturns and ultimately jeopardize the federal government’s AAA rating. Diminished bipartisanship within Congress and the use of the debt ceiling as a means of pressuring political opponents could also raise questions about the willingness of the U.S. government to pay its obligations on time and in full.

RATING RATIONALE

U.S. Economic Fundamentals Remain Strong In Spite of the Slowdown and Increased Trade Frictions

The U.S. economy has enjoyed a steady decade-long recovery from the 2008-09 global recession. The unemployment rate reached 3.5% in September, and labor market slack appears increasingly limited. However, growth has slowed in recent quarters as the impact of the 2017 tax law and budget stimulus has faded. The global manufacturing slowdown and the deteriorating U.S.-China relationship have also increased uncertainty and weakened business confidence. Part of the recent weakness in manufacturing and exports is tied to challenges at Boeing, which could persist for another quarter or possibly more. Risks to growth appear tilted toward the downside, but are tied in large part to U.S. policy on trade, investment, and global security. Medium-term growth prospects remain strong but will gradually shift lower as labor force growth slows.

Long-term interest rates have fallen sharply in the past six months, as business confidence has weakened, compounded by expectations of lower interest rates in Japan and Europe and a strengthening dollar. Despite an economy near full employment and with wages rising over 4% per year in most industries, inflation remains stubbornly below the Fed’s target. The Federal Reserve has consequently shifted its stance, delivering 50 basis points of rate cuts in the last three months. Fiscal policy is likely to lend some additional support to growth in the coming year. With overall household balance sheets in relatively healthy condition and some scope for continued credit growth, DBRS Morningstar expects this recent policy stimulus to help avert an outright recession in coming quarters.

Credit dynamics do not appear to point to increasing risks, and the U.S. financial system is on a stronger footing. In most of the major markets, property prices have increased faster than GDP in recent years, but this reflects in large part the long recovery period from last decade’s housing crash. At present, the rise in prices is slowing as housing markets have cooled in most of the major metropolitan areas. Meanwhile, credit growth has been broadly in line with economic growth. Concerns about housing affordability and rising student loan debt pose some risks to younger borrowers, but the overall net worth of households reached 532% of GDP as of Q2 2019, an all-time high. Household debt service ratios are also well below pre-crisis levels. Overall Tier 1 capital levels of U.S. commercial banks have been steady in recent years between 12.0-12.5% of risk-weighted assets.

External Accounts Are Resilient and a Key Credit Strength

In the first half of 2019, the U.S. current account deficit has remained in line with its decade-long average of 2.5% of GDP. In U.S. dollar terms, the current account has improved slightly, due primarily to an increase in primary income. Unceratinty on trade policy and the imposition of tariffs on China have not materially reduced the U.S. trade deficit. Instead, the countries of origin have shifted, partly to other Asian countries (e.g., Taiwan, Singapore), and imports remain near their peak.

The dollar has strengthened as worries about the global outlook and negative interest rates in Japan and Europe have led to increased flows into U.S. markets. Capital flows into and out of the United States remain highly diverse and resilient. The pace of global reserve accumulation has remained subdued since 2014, but the role of the dollar and the U.S. Treasury market as reserve assets is unlikely to change dramatically. DBRS Morningstar considers the dollar’s role in foreign exchange markets and in international transactions, combined with the attractiveness of the United States as a preeminent global financial center, to be a key credit strength. These factors significantly reduce the risks associated with external borrowing and reduce any risks associated with external deficits and debt.

Fiscal Imbalances, If Unaddressed, Could Weaken U.S. Credit Fundamentals Over the Medium Term.

The United States continues to post relatively large fiscal deficits, resulting in a slow rise in debt even as the economy is estimated to be close to potential. Latest estimates for the 2019 federal fiscal deficit are now a better-than-expected 4.5% of GDP. Revenue growth has picked up during 2019, with YTD net tax receipts up 3.5% as of August 2019, in line with latest CBO projections. Overall expenditure growth remains twice as high, rising 7% YTD as of August. The CBO expects the deficit to widen slightly in 2020, and to remain in the 4.5-5.0% range for the foreseeable future.

In this context, long-term fiscal pressures remain a concern and the U.S. lacks a credible medium-term plan to reduce the deficit. Due primarily to rising entitle spending and interest costs, outlays are expected to rise from 20.6% of GDP in 2018 to 23.6% of GDP by 2028. The cost of social security is expected to fall below the program’s income by 2020. In addition, under current law, several key tax cuts enacted in the 2017 Tax Cuts and Jobs Act are programmed to expire in 2026, but may ultimately be extended by Congress in the future. There is a general lack of bipartisan agreement on how to address the long-term imbalance in social security, on an overall approach to health care reform, or on how to strengthen U.S. tax competitiveness while providing adequate revenue for federal government programs. In structural terms, the IMF expects the general government structural deficit to remain at 6.3% of GDP for the next several years.

Despite these challenges, the U.S. Treasury retains considerable financial flexibility and the market for U.S. government debt is highly liquid. Federal debt held by the public reached 77.8% of GDP in 2018. On a general government basis, the IMF estimated debt at 104.3% of GDP as of 2018, rising to 106.2% in 2019. The average maturity of federal debt held by the public has gradually increased over the past decade, reaching 5.8 years as of end-June 2019. Although the level of government debt is relatively high, U.S. Treasury bills and bonds function as the major global reserve asset, supported by highly credible monetary policy and robust legal protections for global investors in U.S. debt markets. This combined with the extraordinary flexibility of the U.S. economy and strong countercyclical demand for U.S. Treasury obligations makes the United States highly resilient to debt shocks.

U.S. Political Institutions Remain Strong but a Highly Polarized Political Atmosphere Presents a Potential Risk.

U.S. political institutions are highly open and transparent, providing a high degree of public accountability and strong incentives for sound governance. Smooth transitions in power, effective checks and balances among the three branches of government, and open public debate are hallmarks of the U.S. system. The electoral system, federal structure, legislative rules and strict separation of powers generally require bipartisan cooperation to achieve major policy reforms, even when a single party controls the Executive Branch and both houses of Congress. While both parties have at times chafed under these limitations and some potentially productive reforms seem unachievable in this environment, the system provides a high degree of political stability and preserves the rule of law.

Increased polarization is nonetheless a challenge, and weighs on DBRS Morningstar’s assessment of this Building Block. Low levels of trust between the two main parties combined with a divided electorate have generally limited compromise and stymied progress on reforms. Both parties have displayed an unwillingness to compromise due to the diverging priorities of their respective party base. Policy agendas differ significantly across the two parties, generating considerable uncertainty with regards to future policy changes. Compounding these tensions, the President is facing an impeachment inquiry which could further divide the two parties.

Ongoing Congressional inquiries and investigations may harden the positions of the respective parties and lead to further stand-offs. In the near term, this could again lead to a partial government shutdown, and over the medium-term could return to brinksmanship on the debt ceiling. DBRS Morningstar remains concerned regarding the apparently widening gulf between the major party platforms and the resulting increase in uncertainty and policy reversibility associated with federal elections.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments:
https://www.dbrs.com/research/352128/.

Notes:
All figures are in USD unless otherwise noted. Public finance statistics reported on a general government basis unless specified.

The principal applicable methodology is Rating Sovereign Governments, which can be found on the DBRS Morningstar website www.dbrs.com at http://www.dbrs.com/about/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 at http://www.dbrs.com/ratingPolicies/list/name/rating+scales.

The primary sources of information used for this rating include BEA, U.S. Treasury, Department of Commerce, BLS, Federal Reserve, Congressional Budget OfficeIMF, World Bank, BIS, UN, and Haver Analytics. DBRS Morningstar 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 for this rating action. DBRS Morningstar did not have access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

This rating is endorsed by DBRS Ratings Limited for use in the European Union. The following additional regulatory disclosures apply to endorsed ratings:

The last rating action on this issuer took place on April 29, 2019.

Solely with respect to ESMA regulations in the European Union, this is an unsolicited credit rating. This credit rating was not initiated at the request of the issuer.

This rating included participation by the rated entity or any related third party. DBRS Morningstar had no access to relevant internal documents for the rated entity or a related third party

Generally, the conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. DBRS Morningstar’s outlooks and ratings are monitored.

For further information on DBRS Morningstar historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Lead Analyst: Thomas R. Torgerson, Co-Head of Sovereign Ratings, Global Sovereign Ratings
Rating Committee Chair: Roger Lister, Chief Credit Officer, Global FIG and Sovereign Ratings
Initial Rating Date: September 8, 2011

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