DBRS, Inc. (DBRS Morningstar) confirmed the Long-Term Foreign and Local Currency – Issuer Ratings of the United States of America 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 coronavirus pandemic has triggered a sharp recession and deterioration in public finances. The U.S. economy shrank 9.0% in Q2, a record drop in output. The initial Q3 rebound in growth was nonetheless quite strong, supported by augmented unemployment assistance and relief for affected businesses, and most private forecasters expect output to decline between 3.5-4.0% of GDP for the year. Unemployment has dropped markedly from its April peak of 14.7%, but remains elevated at 7.9% as of September.
The Treasury has estimated the FY2020 deficit at $3.1 trillion, or 15% of GDP. Additional stimulus bills are pending in Congress which could reach over $2 trillion, depending on the outcome of ongoing negotiations, the imminent election, and the overall approach of the next administration and congress toward the pandemic response. In DBRS Morningstar’s opinion, the 2021 deficit appears likely to also wind up in double digits as a share of GDP. These large deficits pose a concern, particularly given the relatively poor targeting of stimulus payments and, more importantly, the medium-term fiscal dynamics driven by rising interest and entitlement spending.
Nonetheless, DBRS Morningstar continues to view the ratings as underpinned by the extraordinary resilience of the U.S. economy, dollar, and financial system. An innovative private sector and world-class higher educational system, combined with high levels of protection for civil and religious liberties, remain a significant draw for citizens, immigrants and temporary workers alike. The U.S. dollar and U.S. financial markets remain at the center of world trade and capital flows. Supportive policies from the Federal Reserve have absorbed virtually all of the increased issuance from the coronavirus response, enabling the Treasury to finance the increased borrowing at zero net cost for now. Rising indebtedness may ultimately have an impact on growth prospects for the U.S. economy, but U.S. financial flexibility is unlikely to diminish within the foreseeable horizon.
Triggers for a downgrade include: (1) a failure to reduce projected deficits over the medium-term, which could limit fiscal flexibility in future downturns; (2) a material deterioration in economic and financial resilience, including potential permanent scarring from the current pandemic and the associated policy response; or (3) the use of the debt ceiling as a means of pressuring political opponents, which could raise questions about the willingness of the U.S. government to pay its obligations on time and in full.
The Coronavirus Recession Was Deep; The Coronavirus Recovery is Likely to Progress Slowly
The U.S. economy was enjoying robust economic growth prior to the coronavirus outbreak. In March, the rapid global spread of the virus curbed domestic demand and brought several key sectors of the economy to a virtual halt. Output fell a cumulative 10.1% in the first and second quarter of 2020. The state-led approach to managing the outbreak has provided a high degree of flexibility to respond to local conditions. However, the overall U.S. approach has also achieved limited success in containment. Virtually all states have experienced surges in infection and hospitalization rates at least once in the past six months, and new cases have remained stubbornly high for the nation as a whole. The resilience of the U.S. economy is nonetheless evident in the shape of the recovery thus far. Some sectors rebounded rather sharply starting in May as restrictions were gradually eased. Job growth has continued, albeit at a slower pace during Q3, with roughly 3/5 of the lost jobs regained by mid-September. Unemployment remains elevated at 7.9% as of September, but weekly continuing claims numbers suggest that unemployment has continued to fall in recent weeks.
Looking forward to the next several months, DBRS Morningstar expects the recovery to be gradual, particularly for the most affected sectors in travel, tourism, hospitality and related services. Successful vaccine trials and government support for rapid deployment of vaccines may help accelerate the recovery, but even a best-case scenario seems unlikely to trigger a sudden rebound in business and leisure travel. Meanwhile, with an election just weeks away, political divisions have limited progress in passing additional support to unemployed workers or the most affected companies. DBRS Morningstar nonetheless expects this to ease after the election takes place on November 3. Meanwhile, high savings levels are likely to decline as fear of the virus gradually recedes, lending support to the recovery. In spite of this significant shock, DBRS Morningstar continues to view the U.S. economy as the largest, most resilient, and most flexible economy in the world. This dynamism remains a key credit strength and provides a material uplift to the economic structure and performance building block assessment.
The Federal Reserve and U.S. Financial System are in a Strong Position To Lend Support to the Recovery
The Federal Reserve took action early to cushion the shock from COVID-19, reducing short-term interest rates by a cumulative 150 basis points, with the lower limit back at zero. The Fed has used open market operations to curb market volatility and provide needed liquidity to the market. As of September, Federal Reserve holdings of U.S. Treasuries have increased to $4.45 trillion (20% of GDP), up by roughly $2 trillion since February. Holdings of mortgage backed securities have also increased by $611 billion, while a range of smaller credit facilities (including the corporate credit facility and main street lending program) have grown to over $120 billion in aggregate. Of these, some of the facilities focused on providing short term liquidity (for example, the municipal liquidity facility) have already come down from early peaks.
Inflationary pressures remain muted, in spite of rapid money growth associated with rising savings and the policy response. In its September decision, the FOMC indicated that it maintain an accommodative stance until inflation is running above target, in order to maintain average inflation in line with the 2% target over time and keep long-term inflation expectations anchored at 2%. On a month-over-month basis, inflation dropped briefly into negative territory in March through May, but subsequently rebounded in June and July. Supply-related issues appear to have affected prices for a few items, such as used autos, as vehicle sales rebounded sharply during the summer months. The U.S. nonetheless appears unlikely to see sustained inflationary pressures until the threat posed by coronavirus has largely receded and employment has fully returned to late 2019 levels.
U.S. banks came into the pandemic with a strong starting capital position. Expected losses from the pandemic are likely to be substantial, but also appear likely to remain well within parameters associated with Comprehensive Capital Analysis and Review (CCAR) stress tests. Although overall delinquency rates have begun to tick upward, banks have been allowed to provide forbearance without counting loans as troubled or past due. Consumer loans counted as delinquent and non-business bankruptcy filings have dropped sharply, rather than increase. This could in some cases reflect increased payments given to unemployed workers which has shored up their capacity to pay, but most likely has been directly affected by this new forbearance option. Banks have nonetheless increased loan loss provisions significantly in the first half of the year, which increased from 0.5% of total loans to 2.3%. This puts loan loss reserves in excess of 200% of current NPLs. Only time will tell if provisioning has been sufficient to cover future losses. DBRS Morningstar continues to expect a significant increase in business and consumer delinquencies over the next year, even if masked by forbearance. In addition, stresses on commercial real estate prices appear likely given the impact of the pandemic on business closures. Residential real estate has become more valuable in many suburban and rural areas, supported by increased demand and low mortgage interest rates. Nonetheless, housing prices could still come under pressure, particularly in more densely populated areas with large numbers of permanent job losses and remote work arrangements.
External Accounts Remain Resilient, In Spite of a Widening Current Account Deficit.
External accounts primarily reflect the role of the U.S. dollar and the United States exhibits a high degree of resilience to external shocks. The U.S. current account deficit deteriorated in the second quarter, widening from 2.1% of GDP in Q1 to 3.5% in Q2. This deterioration reflects sharply declining exports of goods and services, as well as a fall in primary income receipts. Imports of goods and services also declined precipitously, but to a slightly lesser extent. The deterioration in the trade balance may in part reflect growth differentials, particularly relative to Europe, but may also reflect the strengthening of the dollar during the first four months of the year. Negative primary income effects relate to decreased returns on foreign equity holdings and weaker earnings from direct investment abroad.
The pace of global reserve accumulation has remained relatively subdued since 2014. Nonetheless, the role of the dollar and the U.S. Treasury market as reserve assets is unlikely to change dramatically. Foreign official holdings of U.S. Treasuries dropped by over $200 billion from February through April, but have subsequently increased as the dollar has begun to weaken. 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 deficits and debt and lend support to this building block assessment.
Record Deficits As the Coronavirus Response Takes Precedence Over the Need for Medium-Term Consolidation
The U.S. federal deficit has been on a gradually increasing trend since FY2015. In 2019, the deficit reached 4.6% of GDP, and was on track to rise modestly in FY2020. Due to the recession and passage of the $1.8 trillion U.S. Coronavirus Aid, Relief and Economic Assistance (CARES) Act, the federal deficit increased to a record $3.1 trillion (14.1% of GDP) for FY2020. The IMF estimates the general government deficit for CY2020 will reach 18.7% of GDP. With most of the CARES Act provisions expiring during 2020, the deficit is expected to decline markedly in 2021. However, both the House and Senate are working on additional coronavirus relief legislation. The House version is significantly larger, proposing another $2 trillion in temporary spending to support state governments, households and affected businesses. Although additional spending may be advisable to lend support to the economic recovery, DBRS Morningstar sees some measures (such as the stimulus checks) as poorly targeted. The first round of checks appears to have had a limited impact on the economy, given the drop in discretionary spending and high propensity to save any increased income.
The medium-term trajectory for fiscal deficits is also problematic, driven mostly by rising entitlement spending and rising interest costs. Neither campaign has articulated any plan or intent to prioritize gradual fiscal consolidation. This will nonetheless become an important consideration for the next administration, particularly if control of the executive branch, House and Senate remains divided. Net cash flows into the OASDI trust funds have been close to zero for the past two years, and the trust fund balance has declined from over 350% in 2010 to 273% in 2019. Spending on health and medicare has stabilized since 2016, but remains high compared to historical averages, at 27.7% of total federal expenditure. The CBO’s long-term projections show sustained primary deficits throughout its 30 year horizon, driven by rising spending on health care and social security. This in turn contributes to projections of rising debt and debt service costs, such that overall federal spending would reach 29% of GDP on average in the final decade of its projections (up from 21% over the past decade).
In spite of this long-term challenge, the U.S. government continues to enjoy unparalleled flexibility in financing deficits. A combination of private sector demand and foreign official demand for safe and liquid debt instruments continues to support the Treasury’s capacity to rollover its debt at an exceptionally low cost. Over the past six months, virtually all of the increased bond issuance emanating from the U.S. Treasury has been absorbed by the Federal Reserve. These strengths continue to lend support to our Debt & Liquidity building block assessment.
Noisy Politics and Polarization Unlikely to Undermine Traditional Strengths of U.S. Institutions
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 vigorous, 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. This system generally provides a high degree of political stability and preserves a strong rule of law.
Increased polarization is nonetheless a challenge and is particularly visible in the tenor of the ongoing election campaign. This continues to weigh 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. Though both sides seem to be able to agree to looser fiscal policy in the context of sudden economic downturns, the tough tax and budget decisions that follow tend to be postponed. The federal debt ceiling has been suspended until 2021. However, if control of Congress remains split, the ceiling appears likely to resurface as a source of leverage in upcoming budget battles.
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.
For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments: https://www.dbrsmorningstar.com/research/368971.
DBRS Morningstar notes that this Press Release was amended on December 15, 2020 to incorporate the link to the methodology and the disclosure for unsolicited ratings in the EU.
All figures are in USD unless otherwise noted. Public finance statistics reported on a general government basis unless specified.
The principal methodology is the Global Methodology for Rating Sovereign Governments, 27 July 2020. https://www.dbrsmorningstar.com/research/364527/global-methodology-for-rating-sovereign-governments
For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.
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.
The primary sources of information used for this rating include BEA, OMB, U.S. Treasury, CBO, Federal Reserve System, Department of Labor, IMF, World Bank, 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 not 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 is an unsolicited credit rating.
This rating is endorsed by DBRS Ratings Limited (DBRS Morningstar) 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 29 April 2020.
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.
With Rated Entity or Related Third Party Participation: NO
With Access to Internal Documents: NO
With Access to Management: NO
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, Managing Director, Co-Head of Sovereign Ratings
Rating Committee Chair: Roger Lister, Managing Director, Chief Credit Officer, Global FI and Sovereign Ratings
Initial Rating Date: 8 September 2011
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