The U.S. avoided a fiscal crisis with an eleventh hour debt ceiling deal, and the markets are recovering from its fainting spell that the U.S. might default for the first time in the nations history.
But the credit-ratings agencies are waiting on the details of the deal, and may stick to their guns that the $2.4 trillion in promised cuts fall short of the $4 trillion they demanded in a "credible" plan to ward off a downgrade by one notch to double A from triple-A.
Both Moody's Investors Service and Standard & Poors tell Fox Business they cant immediately comment on the U.S. debt deal because the details of the cuts are still being hammered out. Both have asked for $4 trillion in cuts over the next decade.
"More cuts are needed to stabilize" the U.S.'s annual budget-deficit-to GDP ratio, S&P tells Fox Business, now at more than 9%.
Both cite the worrisome fact that the U.S. credit markets face the retirement of the baby boomers putting added stress on Social Security and Medicare, and as health reform will enroll potentially 16 million uninsured on Medicaid, and another 16 million on new, state-run health insurance exchanges subsidized by the federal government.
The International Monetary Fund has said that a healthy ratio for countries is 7.5%.
Eyes are on S&P because Moodys has said it would be more forgiving. On Friday, Moodys said that as long as the debt ceiling was raised before the government missed payments, it would likely reaffirm the country's triple-A rating, even though Washington was settling on a deal of "limited magnitude."
However, Moody's tells Fox Business that it may put the U.S.s triple-A rating on a negative outlook, which means the country still risks a downgrade in the medium term.
S&P has been notably pointed in its criticisms. John Chambers, its head of sovereign ratings, said on a client conference call late last week that $4 trillion in cuts is just a good start, and it wants more.
Chambers also indicated that the acrimonious fights in Washington were the most detrimental to the U.S. credit rating outlook. The plans new three-step process under which the government would raise the debt ceiling may risk more uncertainty and infighting, which S&P has already frowned on.
Because of that fighting, S&P was first out of the ratings agencies to fast-track the U.S. on the downgrade trajectory, upping the odds to a 50-50 risk versus saying this past spring the odds were one in three.
Changes in ratings are usually lagging indicators, they usually follow, rather than cause, economic of fiscal chaos. Chambers noted that the threat to downgrade the U.S. rating didnt come from external shocks, but were self-inflicted by the partisan gridlock and disruptive fighting in D.C.
"The impact on the AAA will depend on whether S&P sticks to what it stated back on July 14 when it placed America's rating on negative watch," says Mohamed El-Erian chief executive officer of PIMCO, one of the worlds biggest bond investors. "We have one rating agency out there that said it would downgrade unless certain things happen, and these things are not happening fast enough," El-Erian has said.
Moodys didnt note the infighting as being deleterious to the U.S. debt standing, as S&P did. It did note that the U.S. may come away with its top-notch rating intact if the economy improves next year. The U.S. government, however, has been revising downward its GDP numbers, with the first quarter getting chopped down to just 0.4% growth. The second quarter came in at just 1.3%, which is stall speed.
The U.S. Congress and the White House are settling on a deal that would increase the government's debt ceiling by $2.4 trillion over the next year-and-a-half, and would at the same time cut the deficit by an equal sum over 10 years. The ratings agencies are also awaiting details of a special bipartisan committee to be launched under the new agreement, which would offer cuts for an up or down vote in Congress.
On average, downgrades came six months after an outlook change, while a return to a stable outlook from negative on average happened after 15 months, Chris Turner, head of FX strategy at ING, reportedly said.
The agencies have been more activist lately. In the first quarter, 17 sovereign issuers were downgraded by S&P, and so were 40 corporate issuers including banks. Gary Jenkins of Evolution Securities has noted that Moodys downgraded Greece by nine notches in less than a year and a half, in 440 days. Since 1989 S&P has lowered the ratings of 101 out of 174 sovereigns with negative outlooks.
A downgrade doesnt necessarily mean borrowing rates would rise drastically higher. The U.S. still enjoys safe haven status, and can print dollars. Yields on the ten-year note struggled to stay above 3.5% and actually broke down below 3% during the height of the crisis. Bond markets notably focus on inflation riskthe story now is deflation, which means the U.S. can still borrow at teaser rates for now.
Same goes for Japan. Moodys stripped Japan of its triple-A in 1998 S&P followed in 2001. Japan was hit with further downgrades ever since. Yet although it has the heaviest debt burden in the world, Japan still borrows at rock bottom rates, thanks to deflation and the loyalty of its savers who own most of its debt, unlike the U.S., which relies on foreign buyers like China.
Also, over the last two decades, Canada, Sweden, Finland cut spending after a downgrade, and their economies then boomed. All three got their triple A reinstated.