DBRS, Inc. (DBRS Morningstar) confirmed the United States of America’s Long-Term Foreign and Local Currency – Issuer Ratings at AAA. DBRS Morningstar confirmed 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. The U.S. economy accounts for roughly one-quarter of global output. U.S. financial markets and the dollar are 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. In fact, net interest costs remain well below levels the CBO had projected prior to the pandemic, and are expected to decline further in 2023, in spite of increased public debt.
In spite of these credit strengths, DBRS Morningstar will continue to monitor progress on two interrelated challenges ahead. One, the U.S. public sector balance sheet has deteriorated significantly in the past 15 years as a result of two major economic and financial shocks, and medium-term projections point to a sizeable 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.
The Federal reserve has started to raise interest rates as inflationary pressures mount. A tight labor market, strong household balance sheets, and high levels of accumulated savings are generating strong demand for goods and services. Meanwhile, successive waves of the COVID-19 pandemic have contributed to supply shortages and rising costs for key goods and services. Supply challenges have been exacerbated by Russia’s invasion of Ukraine and a forceful sanctions response led by the U.S. government. With the added uncertainty of a confrontation with Russia and the potential for new COVID-19 variants, the Federal Open Market Committee’s (FOMC) task of engineering a soft landing for the economy is likely to be a challenging one.
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.
The U.S. Economic Recovery is Slowing as Inflation Reduces Purchasing Power and Interest Rates Rise
The U.S. economy has experienced a strong recovery following the deep but short-lived COVID-19 recession in 2020. Aided by a forceful fiscal response, the economy rebounded 5.7% in 2021 and is expected to grow 3.5% in 2022 before converging with trend growth of slightly under 2% by 2024. The expected slowdown will be driven by high inflation (particularly in housing prices), production bottlenecks, and rising interest rates. Similar to past recessions, productivity (measured by real output per hour worked) has increased in the wake of the recession, and productivity growth is likely to be commensurately lower as the recovery continues. Total civilian employment remains only 0.4 million lower than its pre-pandemic peak, due to a lower participation rate, while the unemployment rate has dropped to 3.6% as of March 2022. The savings rate has returned to pre-pandemic levels, but accumulated balances in bank accounts remain unusually high.
The overall size and resilience of the U.S. economy continues to lend support to the Economic Structure and Performance building block assessment. The near term outlook is clouded due to Russia’s invasion of Ukraine, rising commodity prices, and the potential for renewed restrictions on mobility in response to new COVID-19 variants. DBRS Morningstar nonetheless expects U.S. growth prospects to remain relatively strong for an advanced economy.
External and Financial Conditions Point to Limited Near-Term Risks, But Trends Bear Watching
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. The current account deficit has increased during the global pandemic, rising to 3.6% of GDP in Q4 2021. The increase in the deficit reflects relatively strong growth in consumer demand for goods, including imports, and still depressed demand for services. Given its services-oriented economy, we expect some rebound in net U.S. service exports during 2022. Combined with increased global demand for military equipment and related U.S. technology, the deficit could shrink in the near term. However, a strong dollar combined with strong U.S. economic performance relative to major trading partners may continue to put pressure on the current account. Meanwhile, the net international investment position continues to deteriorate, as the value of foreign holdings of U.S. equities has risen sharply following the pandemic. Since 2017, the net liability position has increased from under 40% of GDP to nearly 80% in 2021 (well in excess of the IMF’s October estimate of 71.7%). While we see limited risks associated with these external liabilities, we continue to monitor the impact of capital inflows on domestic financial markets.
Inflation is running high within the U.S. economy, prompting the Federal Reserve to begin a new tightening cycle. In March, the Federal Open Market Committee hiked rates 25 basis points (bps), and signaled that additional rate hikes are likely. Chairman Powell also signaled openness to more aggressive rate hikes if needed to curb inflationary pressures. The FOMC expects some disinflation by the end of the year, partly driven by an expected easing of supply constraints, and in part due to the cumulative impact of expected rate hikes on aggregate demand.
The U.S. banking system appears to be on a significantly stronger footing in the aftermath of the pandemic. Tier 1 capital has declined slightly to 12.9% of risk-weighted assets as of Q4 2021, but remains above pre-pandemic levels. Consumer credit is growing at a pace of 6.1% y/y, as of January 2022. Rising housing prices have spurred increased borrowing. Interest rates on 30-year mortgages are up to 4.5% on average, well above the late 2020 low of just under 3%, but still below the level of rates observed in the mid-2000s, leading up to the housing crisis. Revolving credit growth has ebbed slightly in recent months, and is likely to slow further as rate hikes continue. Households deleveraged in the earliest phase of the pandemic and credit growth has not yet raised significant worries about the average risk profile of lending. Consequently, DBRS Morningstar has given some uplift to our building block assessment for Monetary Policy & Financial Stability. However, DBRS Morningstar will continue to watch for signs of excess credit growth and leverage in coming years.
Cyclical Recovery Underway, but Medium-Term Fiscal Imbalances Remain a Potential Challenge
The U.S. fiscal deficit is declining as temporary pandemic spending expires and the economy recovers. The IMF projects (as of last October) that the general government deficit will narrow from 10.8% of GDP in 2021 to 6.9% in 2022 and 5.7% in 2023. Fiscal outperformance in recent months suggests the IMF projections will likely be revised to show a smaller deficit in 2022 and 2023. The CBO projects that the FY2022 federal deficit will decline to 4.7% of GDP. The Administration has released its 2023 budget proposal, which seeks to trim the deficit relative to the baseline through the introduction of a minimum tax for billionaires and various other reform measures. However, the 2022 Consolidated Appropriations Act, which contained supplemental spending legislation and was not factored into that baseline, will increase the deficit in the near term. The President’s budget proposal also appears to rely on an assumed gradual increase in trend growth within a ten year horizon to keep the federal deficit from widening beyond the 4.5-5.0% range. Several measures in the President’s budget will also be difficult to pass in an election year given the narrow Democratic majorities. The CBO continues to project gradual pressures on public finances over the medium-term, due to rising interest costs and demographics. Defense spending may also increase further over the next few years, depending on the outcome and implications of Russia’s invasion of Ukraine. DBRS Morningstar remains concerned over the lack of a medium-term fiscal strategy.
In spite of 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 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 decline slightly to 130.7% of GDP as of end-2022, before gradually rising 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 drop slightly to 99% in 2022 before rising gradually over the next decade. Net interest payments continue to decline gradually and are expected to reach a low of 1.2% of GDP 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.
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 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. These durable funding advantages give the U.S. government a higher capacity to finance debt and to carry a relatively high debt burden without impairing growth prospects.
Democratic Control Mutes Tensions For Now, But Prospect of Divided Government Looms Again With Mid-Terms
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 frequently controlled by different parties. As a result, legislative negotiations are often challenging, and delays are in large part 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, albeit one we now consider to be reflected in the quantitative assessment of the scorecard without any qualitative adjustments. Low levels of trust between the two main parties combined with a divided electorate have generally limited progress on some reforms. Both parties have displayed an unwillingness to compromise due to the diverging priorities of their respective party base. Even with all three bodies under Democratic control, the administration has struggled to push forward legislative priorities that satisfy its narrow majorities in both the House (a twelve seat majority) and Senate (one seat). With mid-term elections approaching in November, Republicans appear to have a reasonable chance of taking the House and possibly the Senate as well, though Republicans will have to defend a larger number of Senate seats, including those of five retiring Republican senators (versus one retiring Democrat). In addition, Republicans are defending two seats in swing states that voted for President Biden in 2020; no Democratic seats up for election are in states that voted for Donald Trump.
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/395175.
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 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/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (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. Department of Treasury, Office of Management and Budget, Congressional Budget Office, Federal Reserve, Bureau of Economic Analysis, IMF, World Bank, BIS, S&P Corelogic, 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 October 15, 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, Co-Head of Sovereign Ratings
Rating Committee Chair: Nichola James, Managing Director, Co-Head of Sovereign Ratings
Initial Rating Date: September 8, 2011
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