DBRS, Inc. (DBRS Morningstar) confirmed the United States of America’s Long-Term Foreign and Local Currency – Issuer Ratings at AAA, and the Short-Term Foreign and Local Currency – Issuer Ratings at R-1 (high). The trend on all ratings remains Stable.
KEY RATING CONSIDERATIONS
DBRS Morningstar continues to view the United States’ (U.S.) ratings as underpinned by the extraordinary resilience of the U.S. economy, dollar, and financial system. An innovative private sector and world-class system of higher education combined with high levels of protection for individual civil and religious liberties remain a significant draw for citizens, immigrants and temporary workers alike. U.S. financial markets and the dollar remain at the center of world trade and capital flows. Supportive policies from the Federal Reserve have absorbed most of the increased debt issuance from the COVID-19 response, enabling the Treasury to finance the increased borrowing at zero net cost for now. Interest costs as a share of GDP have fallen as a percent of GDP and are projected to decline further through 2023, in spite of increased public debt.
In spite of these credit strengths, DBRS Morningstar will continue to monitor progress with addressing two key challenges ahead. One, the U.S. public sector balance sheet has deteriorated significantly in the past 15 years, the result of two major economic and financial shocks, and medium-term fiscal projections point to a growing structural fiscal deficit. Two, the polarized political environment could have an increasingly adverse impact on the quality and predictability of policy making, particularly with regard to fiscal policy. There is little evidence of any consensus between the two main parties on how to address long-term fiscal imbalances associated with rising entitlement spending. Indeed, current administration priorities include the introduction of additional social benefits (potentially including subsidized childcare, pre-K schooling and community college), but the legislation may not fully account for the likely permanent costs.
The recent tensions over the debt ceiling are symptomatic of the polarization that could have an impact on the U.S. rating. The Senate’s compromise of last week was followed by a House vote on October 12 to increase the ceiling, allowing the administration to sign the legislation only a few days before the Treasury was expected to run out of cash to meet federal obligations. Congress is once again on a path that will likely lead to difficult, recurring, and highly partisan negotiations on the debt ceiling. The incentives to compromise are very strong, even if only at the final hour. DBRS Morningstar considers the likelihood of an actual debt default to be very low, in part because we would also expect the Treasury and Federal Reserve to do everything within their power to avoid payment delays on debt securities. Nonetheless, recurring battles over the debt ceiling raise the potential for miscalculation. A failure to increase the debt ceiling and delaying federal government payments for even a brief period would likely impose a significant toll on the U.S. economy. Given the current fiscal outlook, and depending on the Democrat’s legislative strategy with regard to reconciliation, the debt ceiling may remain a risk throughout 2022 as mid-term elections approach.
The ratings could be downgraded due to one or a combination of the following factors: (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; or (3) increased 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.
Fiscal Policy Supporting the Recovery, but Structural Imbalances Remain a Potential Challenge
The Congressional Budget Office (CBO) projects a federal deficit of 13.4% of GDP in 2021, following the record 14.9% fiscal deficit recorded in 2020. On a general government basis, the IMF projects a deficit of 10.8% of GDP in 2021. Although projected to fall further in 2022 as pandemic relief efforts are gradually reduced, budget discussions are ongoing and could lead to a material increase in deficits in the near term. The CBO continues to project gradual pressures on public finances over the medium-term, due to rising interest costs and demographics. DBRS Morningstar remains concerned over the lack of a medium-term fiscal strategy. Both parties have demonstrated a willingness to use sunset clauses on important tax and spending policy priorities, designed primarily to limit the estimated cost of legislation, rather than delivering adequate permanent fiscal adjustments to meet future spending obligations. Some fiscal flexibility is warranted during downturns, particularly given federal government’s role and the stringent budgetary discipline typically observed at the state and local level. Nonetheless, tax cuts and new spending programs are frequently implemented at the federal level without regard for a clear medium-term fiscal objective.
In spite of these weaknesses in fiscal outcomes at the federal level, U.S. fiscal policy deliberations remain very open and transparent, with elected officials held accountable for results. Deep levels of policy expertise within the civil service, congressional staff, state and local government, academia and the private sector help inform robust public debate. State government units retain a high degree of autonomy in setting tax and spending priorities, particularly for education, health, public utilities, and other government services, thereby enabling the federal government to play a more limited and supporting role. This also somewhat constrains the federal government’s sources of revenue, but supports a high degree of local accountability for the management of public funds.
Public debt has reached historically high levels, though financing costs have dropped and remain near historical lows in nominal and real terms. The IMF expects general government gross debt to reach 133.3% of GDP as of end-2021, and to decline in 2022 before rising marginally to 133.5% of GDP by 2026. This broadly reflects trends at the federal government level. The CBO projects federal debt held by the public will reach 103% of GDP in 2021, gradually rising to 106% within a decade. Net interest payments continue to decline gradually and are expected to reach a low of 1.25% in nominal terms in 2023 before beginning to rise gradually. This favorable environment depends on the expected path of interest rate hikes by the Federal Reserve, but is likely to persist for some years to come, even as interest rates move gradually higher over time. More importantly, we expect real interest rates to remain in negative territory for several years to come.
The resilience of the U.S. Treasury market, which is supported by the use of the dollar as the world’s primary reserve currency, continues to lend support to the Debt & Liquidity building block assessment. The Federal Reserve’s balance sheet has expanded to fund nearly all the increased net issuance of debt to fund the pandemic response, and foreign holdings continue to account for nearly 40% of total outstanding long-term debt. A failure to increase the debt ceiling in a sufficiently timely manner, leading to payment delays on at least some federal programs, would likely lead to a reassessment of these strengths, particularly if such an event led to a durable increase in the average real cost of funding.
The U.S. Economy Is Leading the Global Recovery but is Nearing Potential Output
The United States suffered a deep downturn in 2020 as the economy went through a brief shutdown and gradual reopening in the wake of COVID-19. However, the U.S. economy has performed relatively well in comparison to other advanced economies, and is expected to grow by 6.2% in 2021. This partly reflects the relatively large fiscal response, but also the resilience and flexibility of the U.S. economy. As of September 2021, civilian employment is still 5.0 million lower than it was in January 2020, but firms in some sectors are struggling to fill vacant positions. The economy is still likely to face some headwinds as it recovers from the pandemic, due to labor mismatches, rising input and living costs, and the rising debt burdens faced by some financially vulnerable segments of the population. However, the average consumer has deleveraged during the pandemic and overall household balance sheets are strong.
Although the global outlook remains uncertain with the potential for lingering restrictions on international travel, the overall size and resilience of the U.S. economy continues to lend support to the Economic Structure and Performance building block assessment. Public investment appears likely to receive a boost in coming years, with congress moving toward passage of a $1 trillion infrastructure bill. With much of the new investment going to replace aging infrastructure, it remains unclear if the added investment expenditure will have a material impact on potential growth. DBRS Morningstar nonetheless expects U.S. growth prospects to remain relatively strong for an advanced economy.
The Federal Reserve and U.S. Financial System Remain in a Strong Position to Support the Economy
The Federal Reserve has maintained a highly accommodative stance throughout the pandemic. Inflation has picked up, measured on a year-over-year basis, but this primarily reflects a few transitory shocks relating to the price of autos, gasoline, and other forms of transportation (e.g., airfare). Additional shocks may emerge due to global pandemic restrictions – energy prices, for example, have increased in a range of countries. Inflation is nonetheless likely to gradually decline toward the Federal Reserve’s target over time. Markets appear to expect short-term interest rates to remain at zero through most of 2022. The Federal Reserve may start to reduce the pace of asset purchases next month but we expect the tapering process will be gradual.
The broader financial system is also well-positioned to support the economic recovery. Housing prices have risen significantly across most markets, and could undergo a correction in coming years as interest rates rise. However, this seems unlikely to be widespread or prolonged in the context of a gradual economic recovery with rising household incomes. Consequently, DBRS Morningstar has given some uplift to our building block assessment for Monetary Policy & Financial Stability. Consumer lending is expanding once again, particularly fueled by auto purchases, but also accompanied by a gradual recovery in revolving credit. Meanwhile, delinquencies have declined in absolute and in percentage terms, and bank balance sheets appear well-positioned to weather stresses.
External Accounts Are Resilient And Primarily Reflect the Role of the U.S. Dollar and Financial System.
The U.S. current account deficit has widened from pre-pandemic levels, reaching 3.4% of GDP in the second quarter of 2021. Goods exports have fully recovered across most categories, excluding autos, while service exports remain at depressed levels due to pandemic measures affecting tourism and transportation. A similar dynamic has affected imports, with goods up sharply and services recovering at a slower pace. The U.S. net international investment position dropped from -51.6% of GDP as of end-2019 to -67.8% of GDP in Q2 2021. The rise in external liabilities reflects in part a weakening dollar, the strong performance of U.S. equity markets, and continued inflows into U.S. capital markets. DBRS Morningstar continues to view U.S. external accounts as benefiting from the unique role and position of the U.S. dollar within international finance. This limits external risks and lends support to the Balance of Payments building block assessment.
U.S. Institutions Serve as an Anchor in Times of Polarized Politics, But Complicate Policymaking
U.S. political institutions are highly open and transparent, providing a high degree of public accountability and strong
incentives for sound governance. Changes to federal law, including the budget, must be approved by three separate bodies, the House, the Senate and the Presidency, which respond to different constituencies and are often controlled by different parties. As a result, legislative negotiations are often challenging, and delays are in large part simply a feature of the United States’ pluralistic and competitive presidential system. A slow-moving political process and consensus-oriented decision making, underpinned by the U.S. constitution and court system has long been a key credit strength.
Increased polarization is nonetheless a challenge, and continues to weigh on DBRS Morningstar’s assessment of the
Political Environment building block. Low levels of trust between the two main parties combined with a divided
electorate have generally limited 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 uncertainty with regard to future policy changes. To the extent that institutional constraints are weakened through the actions of a single party, this could increase policy reversibility. On the other hand, the limited room for policy changes raises governability challenges and may delay needed reforms.
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.
For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments: https://www.dbrsmorningstar.com/research/385967.
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.
All figures are in U.S. Dollars 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 https://www.dbrsmorningstar.com/research/381451/global-methodology-for-rating-sovereign-governments (July 9, 2021).
Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings; https://www.dbrsmorningstar.com/research/373262 (February 3, 2021).
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 U.S. Treasury, Office of Management and Budget, Congressional Budget Office, Federal Reserve, Bureau of Economic Analysis, 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 for use in the United Kingdom, and by DBRS Ratings GmbH for use in the European Union, respectively. The following additional regulatory disclosures apply to endorsed ratings:
The last rating action on this issuer took place on April 27, 2021.
With respect to FCA and ESMA regulations in the United Kingdom and European Union, respectively, 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. DBRS Morningstar understands further information on DBRS Morningstar historical default rates may be published by the Financial Conduct Authority (FCA) on its webpage: https://www.fca.org.uk/firms/credit-rating-agencies.
Lead Analyst: Thomas R. Torgerson, Managing Director, Credit Ratings
Rating Committee Chair: Nichola James, Managing Director, Credit Ratings
Initial Rating Date: September 8, 2011
For more information on this credit or on this industry, visit www.dbrsmorningstar.com.
140 Broadway, 43rd Floor
New York, NY 10005 USA
Tel. +1 212-806-3218