S&P Move Is Nudge to U.S. Policymakers
The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.
By Win Thin
NEW YORK (BBH FX Strategy) -- The key takeaway from Standard & Poor's change in its outlook on U.S. debt is that no actual ratings action is likely until 2013, but S&P does seem to be firing a shot across the bow to policymakers.
S&P officials say a downgrade is not inevitable and put the chances at "one in three" with this action.To us, the S&P statement means that the agencies do not have unlimited patience with regard to U.S. fiscal policy and the rising debt load. We note that the IMF recently revised upward its U.S. deficit forecasts as a percentage of GDP for 2011 and 2012 to 10.8% and 7.5%, from 9.7% and 6.6% previously. The 2011 U.S. forecast is the highest in developed markets, although the 2012 forecast has Japan overtaking the U.S. as the worst in developed markets, with -8.4%. U.S. credit-default swaps are up 6 basis points to 50 basis points so far Monday, while Treasury yields are mixed, with the yield on the two-year down 5 basis points and the yield on the 30-year up 7 basis point. The euro is back near the lows of the day after the knee-jerk buying on the S&P news. So, all in all, it appears the markets are digesting the news. With regard to our sovereign rating model, the U.S. is a special case. Despite expanded budget deficits and increased debt issuance, we still view the U.S. as a triple-A credit. Because the dollar is the world's reserve currency (and will remain so for years to come), the U.S. simply gets more leeway from the ratings agencies than other countries with regard to policy risks. We have a dummy variable that accounts for this in our ratings model, and we acknowledge that removing this favorable factor for the U.S. would put it into borderline double-A-plus/Aa1 territory. We do know that rating agencies have inserted themselves into U.S. budget debates before. Moody's (MCO) put some Treasuries on review for possible downgrade (much stronger than negative watch) back in 1996. Why? That was during another budget impasse after Republicans refused to vote to increase the debt ceiling. Back then, markets seemed to recognize the move for what it was, which was an effort to force the White House and Republican congressional leaders to get a deal done. We suspect similar motivations are behind today's move. Back in May 2009, S&P put its triple-A rating for the U.K. on negative watch for a possible downgrade. Then too, S&P said that the chance of a U.K. downgrade was "one in three." However, the agencies were split, as Moody's weighed in that year and said the U.K.'s trajectory would remain consistent with triple-A-rated countries. S&P affirmed the triple-A U.K. rating back in July 2010 after the new government committed to austerity measures, but the ratings agency kept the country on negative watch in case it didn't stick to the ambitious deficit reduction plans. Then in October 2010, S&P revised its U.K. outlook to stable from negative. This is evidence that a negative watch does not automatically lead to a downgrade. That said, the U.K. did take aggressive measures, so U.S. policymakers must know that the current trajectory must be changed. The US does have a slightly longer window of opportunity than the U.K. might have had. One last point is that our ratings model still has the U.K. improving slightly but still in double-A/Aa territory, where we have had it since mid-2009.
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