November 11, 2023 (MLN): Moody's Investors Service (Moody's) has today changed the outlook on the Government of United States of America's (US) ratings to negative from stable and affirmed the long-term issuer and senior unsecured ratings at Aaa.

The key driver of the outlook change to negative is Moody's assessment that the downside risks to the US fiscal strength have increased and may no longer be fully offset by the sovereign's unique credit strengths.

In the context of higher interest rates, without effective fiscal policy measures to reduce government spending or increase revenues, Moody's expects that the US' fiscal deficits will remain very large, significantly weakening debt affordability.

Continued political polarization within US Congress raises the risk that successive governments will not be able to reach a consensus on a fiscal plan to slow the decline in debt affordability.

The affirmation of the Aaa ratings reflects Moody's view that the US' formidable credit strengths continue to preserve the sovereign's credit profile.

First, Moody's expects the US to retain its exceptional economic strength. Further positive growth surprises over the medium term could at least slow the deterioration in debt affordability.

Second, the US' institutional and governance strength is also very high, supported in particular by monetary and macroeconomic policy effectiveness.

While the adjustment of the US economy and financial sector to higher-for-longer interest rates is underway, policymakers have facilitated the transition through transparent and effective policy.

Finally, the unique and central roles of the US dollar and Treasury bond market in the global financial system provide extraordinary funding capacity and significantly reduce the risk of a sudden spiraling of funding costs, which is particularly relevant in the context of high debt levels and weakening debt affordability.

The US' long-term local- and foreign-currency country ceilings remain unchanged at Aaa.

The Aaa local currency ceiling reflects a small government footprint in the economy, relatively predictable and reliable institutions, very low external imbalances and moderate political risks.

The foreign-currency ceiling at Aaa reflects the country's strong policy effectiveness and open capital account which reduce transfer and convertibility risks to minimal levels.

Rating rationale for outlook change to negative from stable:

Absent Policy Action, Fiscal Strength Will Decline

The sharp rise in US Treasury bond yields this year has increased preexisting pressure on US debt affordability.

In the absence of policy action, Moody's expects the US' debt affordability to decline further, steadily and significantly, to very weak levels compared to other highly rated sovereigns, which may offset the sovereign's credit strengths explained below.

Past increases in interest rates by the Federal Reserve will continue to drive the US government's interest bill higher over the next few years.

Meanwhile, although the government's revenue base will rise in line with the economy as a whole, in the absence of specific policy action, this will occur at a much slower pace than the rise in interest payments.

Moody's expects federal interest payments relative to revenue and GDP to rise to around 26% and 4.5% by 2033, respectively, from 9.7% and 1.9% in 2022.

For a reserve currency country like the US, debt affordability – more than the debt burden – determines fiscal strength.

As a result, in the absence of measures that limit the size of fiscal deficits, fiscal strength will increasingly weigh on the US' credit profile.

Fiscal Risks Are Exacerbated By Entrenched Political Polarization Underscoring Rising Political Risk

At a time of weakening fiscal strength, there is an increased risk that political divisions could further constrain the effectiveness of policymaking by preventing policy action that would slow the deterioration in debt affordability.

These risks underscore rising political risk to the US' fiscal position and overall sovereign credit profile.

As annual debt service costs continue to rise, fiscal flexibility will diminish even further.

Rationale For Affirmation Of Aaa Ratings

The affirmation of the Aaa ratings reflects Moody's view that, despite rising fiscal pressures and political risk, the US' formidable credit strengths continue to preserve the sovereign's rating. 

This is attributed to exceptional economic strength, high institutional and governance strength, and the unique and central roles of the US dollar and Treasury bond market in the global financial system.

Environmental, Social, Governance Considerations

The US ESG Credit Impact Score is CIS-2, indicating that ESG considerations are not material to the rating. For the US, this reflects moderately negative exposure to social risks and a strong governance profile that supports the sovereign's resilience and capacity to respond to shocks

At the federal level, the US exposure to environmental risks is neutral to low (E-2) reflecting the country's relatively limited exposure across all categories, including physical climate risk, carbon transition, natural resources management, waste and pollution.

The US' exposure to social risks is moderately negative (S-3), driven mainly by demographics and socioeconomic inequalities.

The US' very strong institutions and governance profile (G-1) supports its overall sovereign credit rating and is reflected in both a strong institutional framework and demonstrated policy effectiveness, especially with regard to monetary and macroeconomic policy.

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Posted on: 2023-11-11T12:51:21+05:00