DBRS Morningstar Confirms the United States of America 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. 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. The cost of Federal borrowing is now rising, but average interest costs on public debt remain close to record lows.

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 still sizeable structural primary deficit. Two, the polarized political environment could have an increasingly adverse impact on the quality and predictability of policy making, including with regard to fiscal policy. There is little evidence of any consensus within either of the two main parties on how to address long-term fiscal imbalances associated with rising entitlement spending.

RATING DRIVERS
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.

RATING RATIONALE

The Economy Is Slowing But Financial Vulnerabilities are Limited

The U.S. economy is slowing in the face of high inflation and rising interest rates, but its resilience and dynamism remain key credit strengths. Headline real GDP growth was slightly negative in the first half of 2022, though real consumption growth remained in positive territory. The negative GDP prints in the first half were driven by strong import growth, and subsequently by a decline in investment. Growth is projected to slow to 1.6% in 2022 and to 1% in 2023 due to the real income effects of high inflation and the rising cost of borrowing. Employment growth has nonetheless remained strong, and job openings remain unusually high as many service and manufacturing positions have been difficult to fill in the post-pandemic recovery. Households are dipping into accumulated savings to sustain consumption spending, with the overall household savings rate down to 5%, from a pre-pandemic average of over 7%.

While the current environment poses a number of risks and near-term growth momentum has all but disappeared, household balance sheets remain in relatively strong condition. Excess savings accumulated in the pandemic combined with rising wages should provide a cushion for consumption growth. At the same time, these factors may make it difficult for the Federal Reserve to bring inflation down. Average productivity, though still up relative to pre-pandemic levels, has deteriorated slightly during 2022 due to the modest contraction in output combined with rapidly rising employment and wages. We nonetheless hold to our positive view on U.S. macroeconomic fundamentals. The unparalleled size, diversification, and resilience of the U.S. economy continue to lend support to the Economic Structure and Performance building block assessment.

Headline inflation appears to have peaked in June 2022, while core inflation has continued rising, fueled by housing costs and other core services. The Federal Reserve initially viewed inflationary pressures as supply driven and likely to be transitory, but may have underestimated the impact of the pandemic on labor force participation, the scale of the U.S. government fiscal response, and the pent up household demand for goods and services. External developments, particularly the Russian invasion of Ukraine, have also contributed to rising inflationary pressures. The Federal Reserve has hiked rates a cumulative 300 bps in nine months, and is expected to continue tightening through early 2023. In our assessment, the Fed’s actions demonstrate a continued resolve to bring inflation back down to the target range. Although this poses near term risks of a recession, these actions are likely to reinforce the credibility of the Federal Reserve system; in part, we view the strength of the U.S. dollar as a reflection of this credibility.

The U.S. Financial System Remains on a Strong Footing to Cope with Potential Losses

Tier 1 capital of U.S. commercial banks declined slightly in Q1 2022 to 13.7% of risk-weighted assets, but remains above pre-pandemic levels. Credit growth has picked up after the pandemic-induced deleveraging, but overall household indebtedness is well below levels from the mid-2000s (in % of GDP terms). Commercial bank loan delinquencies continued to decline as a share of total loans and leases through the second quarter of 2022, falling to under 1.2%. Non-mortgage consumer lending shows some increase in delinquencies, up to 1.7% as of Q2. Albeit still at low levels historically, the number of loans and leases considered delinquent (30+ days overdue) or seriously delinquent (90+ days) is beginning to rise and is likely to increase further in coming quarters. However, we see limited risks to financial stability even in the event of a significant rise in unemployment or a sizeable downturn in property prices. This lends support to the Monetary Policy and Financial Stability building block assessment.

External Accounts are Deteriorating Due to Dollar Strength, Safe Haven Flows, and Weaker Returns on Risky Foreign Assets

The U.S. current account deficit has widened significantly in the wake of the COVID-19 pandemic. In 2021, the deficit reached 3.6% of GDP, from a deficit of 2.1% of GDP in 2019. The deficit continued to deteriorate in Q1 2022, reaching 4.6% of GDP, but reversed somewhat in Q2 (4.0%) thanks to rising prices for food and energy exports. Most of the deterioration stems from strong import growth during the pandemic recovery phase, as U.S. consumption patterns shifted toward tradable goods. In addition, primary income receipts (driven by returns on foreign assets) have not recovered as strongly as primary income payments (returns on U.S. assets held by foreigners). Increased remittance payments have also increased the deficit. The net international investment position has improved slightly in recent quarters, in spite of the strong dollar, with both assets and liabilities declining due to the global equity market downturn. The drop in external liabilities also reflects foreign central banks (particularly China and Japan) selling a portion of their holdings of U.S. Treasuries to intervene in FX markets in support of their own currencies. 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 risks and lends support to the Balance of Payments building block assessment.

Lack of Appetite for Medium-Term Adjustments to Non-Discretionary Spending Remains a Potential Challenge

The U.S. fiscal deficit has declined sharply in 2022, primarily due to the expiration of pandemic-related spending and tax measures. On a general government basis, the IMF projects the deficit will fall from 10.2% of GDP in 2021 to 4.8% of GDP in 2022 and decline further to 4.0% of GDP in 2023. The CBO baseline similarly projects a decline in the federal deficit to 4.2% in 2022 and 3.5% in 2023. After 2024, the Congressional Budget Office (CBO) and IMF both project a rise in fiscal deficits, driven primarily by rising interest costs. The IMF projections show a continued decline in the primary deficit to 1.7% of GDP by 2027, which is only slightly higher than the CBO projection of a Federal primary deficit of 1.5% of GDP.

Medium-term CBO projections remain a source of concern, due to the seemingly inexorable rise in debt held by the public sector and in interest costs. The federal budget is expected to see continued pressures on non-discretionary spending, gradually squeezing out discretionary spending (in real terms) in order to keep the primary deficit between 1.3-1.7% of GDP. Net interest expenditures are expected to rise from 1.6% of GDP in 2022 to nearly double that amount (3.1% of GDP) within a decade. As a result, federal debt held by the public and general government gross debt are expected to rise by roughly one percentage point per year from 2024 onwards. While the adjustments needed to reduce the primary deficit and stabilize debt are modest in scope, the appetite for fiscal tightening appears limited, particularly ahead of upcoming mid-term elections. The average interest rate on debt held by the public reached a low of 1.6% at end-2021, but has risen to 2% as of August 2022, reflecting the sharp rise in U.S. interest rates.

The Biden administration put forward a 2023 budget that contains some measures to reduce the federal deficit, primarily in the form tax increases. Key proposals included a higher corporate income tax rate, a higher top marginal income tax rate, and the adoption of an undertaxed profits rule to impose a minimum rate of taxation on corporations. The budget includes some additional spending measures on health and education, but also would seek to limit discretionary spending (both defense and non-defense) increases to 1% for the next decade. If implemented, these measures would help to limit the increase in federal debt. If accompanied by marginally higher growth (between 2.0-2.3%), debt would likely stabilize at current levels, in line with the latest Office of Management and Budget (OMB) assumptions. Nonetheless, the latest projections have not incorporated the administration’s proposal for a broad-based reduction in student loan debt, and DBRS Morningstar remains concerned over the lack of a medium-term fiscal strategy.

The U.S. Maintains a High Degree of Financing Flexibility

In spite of weaknesses in fiscal outcomes at the federal level, the U.S. retains an unusually high degree of flexibility in financing its debt. 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. Demand for Treasury securities is consistently strong, coming from a wide range of banks, official sector buyers, and other investors in need of highly liquid assets. In spite of recent sales of USD assets by a few major foreign central banks for FX intervention purposes, official holdings account for roughly one-third of outstanding debt held by the public. The durable funding advantages enjoyed by the U.S. government provide a higher capacity to finance debt and to carry a relatively high debt burden without harming 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. 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 (an eight 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). Tensions between the two parties could again foil attempts to reduce projected fiscal deficits or to increase the public debt ceiling in a timely manner.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS

There were no Environmental/ Social/ Governance factor(s) that had a significant or relevant effect on the credit analysis.

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/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments. https://www.dbrsmorningstar.com/research/403952.

Notes:
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/401817/global-methodology-for-rating-sovereign-governments, 29 August 2022. In addition, DBRS Morningstar uses the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings, https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (May 17, 2022) in its consideration of ESG factors.

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 sources of information used for this rating include U.S. Department of Treasury, Federal Reserve, Congressional Budget Office, Office of Management and Budget, Bureau of Economic Analysis, Bureau of Labor Statistics, IMF, World Bank, 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 April 12, 2022.

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: https://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, Global Sovereign Ratings
Rating Committee Chair: Nichola James, Managing Director, Global Sovereign Ratings
Initial Rating Date: 8 September 2011

For more information on this credit or on this industry, visit www.dbrsmorningstar.com.

DBRS, Inc.
140 Broadway, 43rd Floor
New York, NY 10005 USA
Tel. +1 312 696-6293