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, its public institutions and financial markets continue to provide support to the AAA rating. The U.S. economy is exceptionally large, accounting for one-quarter of global output, and highly resilient given its diversification, flexible labor markets, and innovative and competitive private sector. The country benefits from well-established democratic institutions, a strong legal system, and transparent governance. In addition, U.S. financial markets and the U.S. dollar are at the center of world trade and capital flows, thereby providing the U.S. with an unusually high degree of financing flexibility.

In spite of these credit strengths, DBRS Morningstar is monitoring two interrelated challenges which could impact credit fundamentals. First, the government balance sheet has deteriorated significantly over the past 15 years due to two major economic and financial shocks (the global financial crisis and the COVID-19 pandemic). Unless the government addresses its sizable structural fiscal deficit, public debt metrics are expected to continue deteriorating over the medium term, potentially damaging the country’s economic prospects and resilience to shocks.

Second, political polarization could have an increasingly adverse impact on the quality and predictability of policymaking. This includes the current negotiations over the debt ceiling, where polarization in the context of a divided congress has raised the prospect of brinksmanship. Although DBRS Morningstar views it as highly unlikely, failure to raise the debt ceiling in a timely manner could potentially result in a default. Moreover, even if a compromise is reached, as expected, the repeated threat of default from debt ceiling confrontations could damage the U.S. reputation for stability, safety, and predictability.

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) the failure to raise the debt ceiling in a timely manner or the 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 And The Recent Bank Turmoil Increases Recession Risk

The U.S. economy is running above capacity, as evidenced by elevated inflation and a red hot labor market, but growth is slowing under the weight of tighter monetary policy. While fourth quarter headline GDP growth figures suggest that the U.S. continued to grow at a strong pace (2.6% quarter over quarter, annualized), the composition of growth reveals that the economy lost momentum. Final sales to private domestic purchasers, a good proxy for domestic demand, was flat relative to the previous quarter. The muted underlying performance was due to downturns in sectors that are sensitive to rising interest rates, specifically goods consumption and residential investment.

With economic momentum fading at the end of last year, the prognosis for growth in 2023 is weak, in DBRS Morningstar’s view. Consumers continued to spend at a robust clip in January, which will likely sustain positive GDP growth in the first quarter, but households are becoming more discerning in their spending decisions as their savings buffers run down and the weaker economic outlook instills some caution. It is our expectation that the economy will run close to stall speed for the next 2-3 quarters as the full impact of monetary policy tightening is transmitted to the real economy. The labor market continues to be extraordinarily tight but there are some signs of cooling. The quits rate, for example, is still elevated but has declined over the last 12 months, which indicates that employed workers may be becoming less confident in their ability to find jobs elsewhere. The recent turbulence in the banking sector presents downside risks to the outlook. Tighter credit conditions could adversely impact investment and private consumption, thereby raising the risk of recession later this year. Growth is expected to pick up modestly but remain below trend in 2024, as inflation moderates and monetary policy becomes slightly less restrictive.

Overall, DBRS Morningstar continues to hold a positive view on the fundamental strengths of the U.S. economy. The U.S. is the largest economy in the world, highly diversified, and resilient to shocks. In addition, the U.S. is a global leader in innovation and research. Economy-wide productivity levels are elevated compared to other advanced economies. These factors lend support to the Economic Structure and Performance building block assessment.

External Accounts Reflect Dollar Strength And Safe Haven Flows

The U.S. current account deficit has widened in the wake of the COVID-19 pandemic. From 2019 to 2022, the deficit increased from 2.1% of GDP to 3.7%. Most of the deterioration stems from strong import growth as the U.S. economy rapidly recovered from the shock of the pandemic and consumption patterns shifted toward tradable goods. Primary income receipts (driven by returns on foreign assets) also did not recover as strongly as primary income payments (returns on U.S. assets held by foreigners), and remittance payments abroad increased markedly. Looking ahead, weaker import demand, as the economy slows, should help narrow the current account deficit.

In spite of the strong dollar, the net international investment improved in 2022. International assets and liabilities declined due to the global equity market downturn, but the latter declined by more. The drop in external liabilities also reflected 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.

Rapidly Rising Rates Are Moderating Domestic Demand And Have Recently Put Stress On Parts Of The Banking System

Headline year-over-year inflation is falling but remains uncomfortably high. Annual inflation declined from its peak of 9.1% in June 2022 to 6.0% in February 2023. The easing in the headline data largely reflects declining energy prices and smaller price increases for food. Annual core inflation shows few clear signs of receding so far. However, a look at the month-over-month data reveals that core price pressures in two key areas are already moderating or are set to moderate: core goods and shelter. The combination of these forces bode well for the inflation outlook for 2023, although the ongoing strength of non-shelter services could slow the pace of disinflation.

To quell inflationary pressures, the Federal Reserve has hiked the federal funds rate by 475 bps in the last 13 months, taking the policy rate to 4.75%-5.0%. The Fed anticipates that some additional tightening may be needed before reaching the peak rate. In DBRS Morningstar’s assessment, the Fed’s actions demonstrate its resolve to bring inflation back down to the target range. Although this poses near-term risks of a recession, these actions reinforce the credibility of the Fed in preserving price stability.

The rapid rise in interest rates, however, has put stress on parts in the banking system. The recent bank failures and deposit outflows at various financial institutions will likely lead to tighter credit conditions, although the extent of the tightening is difficult to gauge. While U.S. regulators reacted aggressively in order to calm financial markets, the possibility of further contagion presents downside risk to financial markets and the economy. Notwithstanding the uncertainty, DBRS Morningstar views U.S. banks overall as having sufficient liquidity and capital to navigate the market turbulence. New and pre-existing Fed facilities should help ease liquidity pressures. U.S. commercial banks posted Tier 1 capital in Q3 2022 at 13.7% of risk-weighted assets, which is slightly above pre-pandemic levels. Credit growth has picked up after the pandemic-induced deleveraging, but overall household debt servicing costs are well below levels from the mid-2000s (as a share of disposable personal income). Nonperforming loans continue to decline as a share of total loans, reaching historically low levels in the third quarter of 2022. These factors lend support to the Monetary Policy and Financial Stability building block assessment.

The Absence Of A Strategy To Put Fiscal Accounts On A Sustainable Path Could Weaken U.S. Creditworthiness Over The Medium Term

The federal fiscal deficit declined sharply as the pandemic-related tax and spending measures were wound down. In response to COVID-19, the government provided households and firms with substantial fiscal support. The federal deficit reached 14.9% of GDP in 2020 and 12.3% in 2021. As those measures expired, the deficit narrowed to 5.2% in 2022 (adjusted to exclude the effects of timing shifts). The Congressional Budget Office (CBO) projects that the deficit will remain relatively stable at 5.3% in 2023. On a general government basis, the IMF estimates a deficit of 5.7% of GDP in 2023.

However, the medium-term fiscal outlook is a source of concern. The deficit is projected to increase to 6.1% of GDP in 2024 and 2025 and then decline to 5.5% by 2027, assuming certain provisions in the 2017 tax cuts expire, as scheduled. However, the deficit is projected to persistently increase after 2027, reaching 6.9% in 2033 (the end of the projected horizon). The increase in the deficit is primarily driven by rising Social Security and Medicare spending, as well as higher interest costs. As a result, federal debt held by the public is expected to rise from 97% of GDP in 2022 to 105% in 2027, and then rise quickly thereafter. While the fiscal adjustment needed to stabilize debt dynamics is relatively modest in scale, the political appetite for fiscal tightening appears limited.

The U.S. Maintains a High Degree of Financing Flexibility But The Debt Ceiling Poses A Near-Term Risk

In spite of poor 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 of the public sector. The durable funding advantages provide the U.S. government with a higher capacity to finance debt and to carry a relatively high debt burden without harming growth prospects.

However, failure to raise the debt ceiling in a timely manner could have significant adverse consequences for the U.S. economy and, although DBRS Morningstar thinks it is highly unlikely, it could potentially result in a default. The U.S. Treasury announced in January 2023 that the government had reached the debt ceiling and would rely on extraordinary measures to finance operations and service debt obligations. Without additional borrowing, the government will likely exhaust available resources by summer or early fall, although it is too early to know the precise timing. President Biden has called for an increase in the debt ceiling without conditions, while Republican leadership in the House has demanded large spending cuts. Even if a compromise is reached, as expected, the repeated threat of default from debt ceiling confrontations could damage the U.S. reputation for stability, safety, and predictability.

Divided Government Amid Heightened Political Polarization Set The Stage For Debt Ceiling Standoff

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. With low levels of trust between the two main parties and a deeply divided electorate, polarization appears to have weakened centrist politics and strengthened extreme posturing. Both parties have displayed an unwillingness to compromise due to the diverging priorities of their respective party base. With control of congress currently split between Democrats and Republicans, the highly polarized political environment raises the prospect of debt ceiling brinksmanship and government shutdowns and reduces the likelihood of fiscal reforms needed to address long-term sustainability.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS

There were no Environmental/ Social/ Governance factors 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 (May 17, 2022) 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/412474.

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 (August 29, 2022) https://www.dbrsmorningstar.com/research/401817/global-methodology-for-rating-sovereign-governments. 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 in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.

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, Federal Reserve Board, Congressional Budget Office, Office of Management and Budget, Bureau of Economic Analysis, Bureau of Labor Statistics, Bank for International Settlements, International Monetary Fund, 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.

The 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, management 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 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. For further information on DBRS Morningstar historical default rates published by the Financial Conduct Authority (FCA) in a central repository, see https://data.fca.org.uk/#/ceres/craStats.

Lead Analyst: Michael Heydt, Senior Vice President, Global Sovereign Ratings
Rating Committee Chair: Nichola James, Managing Director, Global Sovereign Ratings
Initial Rating Date: September 8, 2011

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

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