Morningstar DBRS Confirms the United States of America at AAA, Stable Trend

DBRS, Inc. (Morningstar DBRS) confirmed the United States of America’s Long-Term Foreign and Local Currency – Issuer Ratings at AAA. At the same time, Morningstar DBRS confirmed the United States of America’s Short-Term Foreign and Local Currency – Issuer Ratings at R-1 (high). The trend on all ratings is Stable.

KEY CREDIT RATING CONSIDERATIONS
The Stable trend reflects Morningstar DBRS’ 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 due to 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, which provides the U.S. with an unusually high degree of financing flexibility.

Notwithstanding these credit strengths, two interrelated challenges could impact U.S. credit fundamentals over time. First, the federal fiscal deficit is projected to hover around 5-6% of GDP from 2024 to 2034, according to the Congressional Budget Office (CBO). Unless the government addresses its sizable structural deficit, public debt metrics will continue deteriorating over the medium term, potentially damaging the country’s economic prospects and resilience to shocks. Second, heightened political polarization may complicate efforts to implement reforms needed to address the country’s growing public finance challenges.

CREDIT RATING DRIVERS
The credit ratings could be downgraded due to one or a combination of the following factors: (1) a failure to reduce projected fiscal deficits over the medium term, (2) a material deterioration in economic and financial resilience, or (3) a failure by Congress to lift the debt ceiling thereby forcing the Treasury to materially delay non-debt payments.

CREDIT RATING RATIONALE
The Economy Continues To Show Resilience In Spite Of Tight Monetary Policy

Morningstar DBRS holds 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 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. It is also worth noting that there are few signs of economic scarring in the aftermath of the COVID-19 shock: real GDP is broadly in line with its pre-pandemic trend and the prime-age labor force participation rate is above its pre-pandemic level.

The U.S. economy continues to perform remarkably well. Economic activity accelerated in the second half of 2023 even as tight labor market conditions gradually loosened. Output increased 4.9% (q/q) annualized in the third quarter and 3.4% (q/q) in the fourth quarter, on the back of strong consumer spending and higher government expenditure. Households are benefiting from healthy balance sheets and a strong jobs market. Despite higher interest rates, household debt-servicing payments as a share of disposable income is near a 40 year low. At the same time, the labor market is looking better balanced. This is due to increased supply and moderating demand. Most sectors continue to experience job gains even as the unemployment rate has ticked up marginally. Market rebalancing is leading to lower wage pressure. The quits rate, for example, has returned to its pre-pandemic level, which is consistent with a looser market and slowing compensation costs.

While momentum from the second half of last year looks set to support solid growth in the first quarter of 2024, we still expect tighter monetary and fiscal policies to slow activity to a below-trend pace over the rest of the year. With the personal saving rate running at a low level and borrowing costs elevated, consumers could become more selective in their purchases. Labor market conditions will remain healthy but likely soften through the year. The fiscal stance should also be more neutral relative to 2023. Growth is expected to slow slightly in 2025, even as interest-rate sensitive sectors will likely benefit from the Federal Reserve’s anticipated shift toward a less restrictive monetary policy.

External Accounts Reflect Dollar Strength And Safe Haven Flows

The U.S. current account deficit is narrowing as domestic demand moderates. This is a reversal of dynamic that played out during the pandemic and its immediate aftermath. From 2019 to 2022, the current account deficit increased from 2.1% of GDP to 3.8%. Most of the deterioration stemmed from strong import growth as the U.S. economy rapidly recovered from the pandemic and consumption patterns shifted toward tradable goods. In addition, primary income payments (returns on U.S. assets held by foreigners) recovered more quickly than primary income receipts (driven by returns on foreign assets) and remittance payments abroad increased markedly. In 2023, weaker import demand helped narrow the current account deficit to 3.0%, and we expect this trend to continue in 2024.

In spite of the strong dollar, the net international investment position was relatively stable in 2023. International assets and liabilities increased marginally relative to 2022, in part due to the recovery in global equity markets. Foreign holdings of U.S. Treasuries increased in 2023, following the drop the prior year when foreign central banks (particularly China and Japan) sold a portion of their U.S. Treasury holdings in order to intervene in FX markets and support of their own currencies. Morningstar DBRS views 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.

The Strength Of The Economy Is Delaying The Pivot Toward Rate Cuts

The inflation outlook has clearly improved but continues to be a challenge for the Federal Reserve. Annual core CPI inflation declined to 3.8% in February 2024, well down from its peak of 6.6% in September 2022. Part of the disinflationary trend has been driven by declining core goods prices, which have benefitted from normalizing supply chains. Shelter inflation also appears to have turned a corner as the lagged effects of a cooler housing market are now leading to lower inflation in both tenant and owners’ equivalent rent. Underlying services inflation excluding shelter has recently accelerated but should ease over time as wage growth moderates. Nevertheless, there is a risk that persistent services inflation, combined with new disruptions in global supply chains, could slow inflation’s return to two percent.

The Federal Reserve has kept the federal funds rate at 5.25%-5.5% for the last nine months. While the Fed is expected to start cutting this year, the monetary policy stance will likely remain tight through 2024 and 2025. According to the latest Summary of Economic Projections, the median forecast for the federal funds rate is 4.6% at the end of 2024 and 3.9% at the end of 2025. This is well above the longer-run projection of 2.6%. Policymakers also signaled that the Fed could begin to taper quantitative tightening at some point soon. In our assessment, the Fed’s actions demonstrate its resolve to bring inflation back down to the target. Although restrictive monetary policy settings pose headwinds to near-term growth, these actions reinforce the credibility of the Fed in preserving price stability.

The banking system as a whole looks relatively well-positioned to navigate potential market turbulence. Net interest margins are slightly above pre-pandemic levels, despite higher funding costs, and non-performing loans are close to historical lows. Commercial banks posted Tier 1 capital in Q3 2023 at 14.4% of risk-weighted assets, which is above prepandemic levels. Moreover, many banks are retaining earnings in order to meet new capital requirements. These factors lend support to the Monetary Policy and Financial Stability building block assessment. Nevertheless, the rapid rise in interest rates has put stress on some parts of the banking system. In particular, troubles in commercial real estate have led to some sizable losses and will likely continue to weigh on banks’ financial performance.

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

The medium-term fiscal outlook is a source of concern. The CBO projects the federal deficit to hover around 5-6% of GDP from 2024 to 2034 (including the effects of the Fiscal Responsibility Act of 2023). Given the cyclical strength of the economy, the deficit reflects a structural imbalance. Moreover, Morningstar DBRS believes that the risks to deficit outlook are skewed to the upside. The fiscal results could deteriorate if part or all of the 2017 tax cuts are extended, the growth in defense spending outpaces expectations, or interest costs increase more than anticipated.

Federal debt held by the public is expected to rise from 97% of GDP in 2023 to 109% in 2030, and then rise more quickly thereafter. If policymakers are unwilling or unable to address the government’s sizable and growing fiscal imbalance, public debt metrics will continue to deteriorate over the medium term, potentially damaging the country’s growth prospects and resilience to shocks. At the moment, however, the political appetite for fiscal reform appears limited.

The U.S. Maintains A High Degree Of Financing Flexibility

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 sales of USD assets by a few major foreign central banks for FX intervention purposes in 2022 and a sizable increase in nominal US$ debt issuance, official holdings at the end of 2023 still accounted for roughly one-third of outstanding debt held by the public. The durable funding advantage provides the U.S. government with a higher capacity to finance debt and to carry a relatively high debt burden without harming growth prospects.

Political Polarization Could Make It More Difficult To Address Key Credit Challenges

The 2024 presidential election is set for a rematch between incumbent Democratic President Joe Biden and former Republican President Donald Trump. The two candidates are advancing markedly different policy proposals, especially in the areas of taxation, climate and energy, and foreign policy. However, congressional elections will also play a key role in shaping policy. In the case of divided government, which we think is the most likely outcome (although far from assured), many of the candidates’ legislative proposals will be watered down or blocked all together. As a result, policy outcomes may not differ as much as the campaigns’ proposals suggest. Regardless of who wins the presidency, we expect limited progress on fiscal consolidation and a continuation of the protectionist posturing seen under the last two administrations.

The U.S. benefits from effective checks and balances, strong rule of law, and high levels of openness and transparency. This provides 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.

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 base. With control of congress currently split between Democrats and Republicans, the highly polarized political environment reduces the likelihood that Congress will enact reforms needed to address the country’s key credit challenges.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS

There were no Environmental, Social, or Governance factors that had a significant or relevant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (January 23, 2024) at https://dbrs.morningstar.com/research/427030/morningstar-dbrs-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://dbrs.morningstar.com/research/430886/.

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 (October 6, 2023) https://dbrs.morningstar.com/research/421590/global-methodology-for-rating-sovereign-governments. In addition, Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings https://dbrs.morningstar.com/research/427030/morningstar-dbrs-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://dbrs.morningstar.com/about/methodologies.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS’ outlooks and credit ratings are monitored.

The primary sources of information used for this credit rating include the 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. Morningstar DBRS considers the information available to it for the purposes of providing this credit rating was of satisfactory quality.

The credit rating was not initiated at the request of the rated entity.

The rated entity or its related entities did not participate in the credit rating process for this credit rating action.

Morningstar DBRS 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 credit rating action.

This is an unsolicited credit rating.

This credit 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 credit ratings:

The last credit rating action on this issuer took place on October 10, 2023.

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 Morningstar DBRS historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: https://registers.esma.europa.eu/cerep-publication. For further information on Morningstar DBRS 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: Thomas R. Torgerson, Managing Director, Global Sovereign Ratings
Initial Rating Date: September 8, 2011

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