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 governing institutions, and deep 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 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 6% of GDP from 2025 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 Structural Strengths of the U.S. Economy Support the AAA Credit Ratings

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. 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 is slowing but continues to perform very well. The economy expanded 2.4% annualized in the first half of 2024, supported by solid consumer spending and robust private investment. Households are benefiting from rising household wealth, robust real income gains and, despite higher borrowing costs, modest interest payments. Households' debt-servicing payments as a share of disposable income is near its lowest level since 1980. The labor market is cooling but underlying conditions continue to be strong. Payroll gains have slowed, job opening have fallen back to prepandemic levels, and the unemployment rate ticked up by half a percentage point since the start of the year. However, the prime-age employment ratio is near its highest level in two decades and layoffs remain low. With easing labor demand and increasing labor supply, the jobs market appears to be in better balance relative to six months ago.

Morningstar DBRS continues to expect a soft landing. Growth looks set to slow to a slightly below-potential pace over the next few quarters. Labor market conditions are expected to soften but avoid a sharp deterioration. Rate-sensitive sectors, such as housing and consumer durables, will likely benefit next year as the Federal Reserve moves toward a more neutral rate setting. The IMF projects growth to moderate from 2.6% in 2024 to 1.9% in 2025. However, elevated geopolitical tensions pose downside risks to the outlook, in Morningstar DBRS' view. Escalating regional conflicts and fragmenting economic ties could disrupt trade and global supply chains, and thereby weaken growth prospects.

An Easing Cycle is Underway as the Federal Reserve Shifts Its Focus from Inflation to the Labor Market

The inflation outlook has clearly improved. Headline CPI inflation was 2.0% (six-month, annualized) in August; core CPI inflation was slightly higher at 2.7%. Part of the disinflationary trend has been driven by declining core goods prices, which have benefitted from normalizing supply chains. Shelter inflation has 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. Core services inflation excluding shelter has also recently decelerated as labor supply and demand have become better aligned. Risks to the outlook appear two-sided. New disruptions in global supply chains or the application of widespread tariffs by the U.S. could generate upward price pressures; alternatively, inflation could run below target if the labor market weakens more than expected.

With inflation risk declining and employment risk increasing, the Federal Reserve initiated an easing cycle in September by cutting the federal funds rate by 50 basis points. This takes the federal funds rate at 5.0%-4.75%. According to the Summary of Economic Projections (September), the median forecast for the federal funds rate is 4.4% at the end of 2024 and 3.4% at the end of 2025. The median longer-run projection of the federal funds rate is 2.9%, which suggests that policy settings will remain at least modestly restrictive through next year. In addition, in May 2024 the Fed tapered the pace of decline in its securities holdings but has not indicated a timeline for when it plans to end balance sheet runoff. In Morningstar DBRS' assessment, the Fed's actions over the last 2-3 years have guided inflation back to the target and reinforced its inflation-fighting credibility. As of last week, the implied 5-year spot breakeven inflation rate is 2.0%.

The rapid rise in interest rates in 2022 and 2023 did put stress on some parts of the financial system, but banks as a whole have navigated the market turbulence relatively well. Declining commercial real estate valuations, particularly office space, have led to sizable losses and will likely continue to weigh on the financial performance of some banks and non-bank financial institutions. Lower-income households have also increasingly come under financial stress, which has contributed to higher delinquencies on consumer loans and credit cards. However, broader trends point to strong capital levels and stabilizing asset quality. Commercial banks posted Tier 1 common equity in Q2 2024 at 13.4% of risk-weighted assets, which is above prepandemic levels, and many banks are retaining earnings in order to meet new capital requirements. Moreover, the share of non-performing loans has increased marginally over the last year but is still below 2019 levels. These factors lend support to the Monetary Policy and Financial Stability building block assessment.

External Accounts Reflect Dollar Strength and Safe Haven Flows

The U.S. current account deficit has narrowed as domestic demand has moderated. 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 3.9%. 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. As growth shifted into a lower gear in 2023, import demand weakened and helped narrow the current account deficit to 3.3%. The current account deficit is expected to remain around 3% in 2024 and 2025.

The net international liability position of the U.S. has increased over the last two years. International liabilities have increased more than international assets, largely due to large direct investments and outsized gains in American equity markets relative to foreign equity markets. The strength of the dollar has also played a role. 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 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 6% of GDP from 2025 to 2034. Given the cyclical position 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 remain at higher levels than anticipated.

Federal debt held by the public is expected to rise from 99% of GDP in 2024 to 113% 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 weakening 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, lends 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 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

Democratic Vice President Kamala Harris is running against former Republican President Donald Trump in the 2024 presidential election. The two candidates are advancing markedly different policy proposals, especially in the areas of taxation, climate and energy, and foreign policy. 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 interest in 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 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 divided government, 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 Factors in Credit Ratings (13 August 2024) https://dbrs.morningstar.com/research/437781.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments: https://dbrs.morningstar.com/research/440921.

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 (15 July 2024) https://dbrs.morningstar.com/research/436000. In addition, Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings https://dbrs.morningstar.com/research/437781 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 these credit ratings 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 April 8, 2024.

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, Sector-Lead Global Sovereign Ratings
Rating Committee Chair: Thomas R. Torgerson, Managing Director - Global Sovereign Ratings
Initial Rating Date: September 8, 2011

For more information on this credit or on this industry, visit https://dbrs.morningstar.com.

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