Moody's may shift U.S. rating outlook on tax package

NEW YORK (Reuters) - Moody's warned on Monday that it could move a step closer to cutting the U.S. Aaa rating if President Barack Obama's tax and unemployment benefit package becomes law.

The plan agreed to by President Barack Obama and Republican leaders last week could push up debt levels, increasing the likelihood of a negative outlook on the United States rating in the coming two years, the ratings agency said.

A negative outlook, if adopted, would make a rating cut more likely over the following 12-to-18 months.

For the United States, a loss of the top Aaa rating, reduce the appeal of U.S. Treasuries, which currently rank as among the world's safest investments.

"From a credit perspective, the negative effects on government finance are likely to outweigh the positive effects of higher economic growth," Moody's analyst Steven Hess said in a report sent late on Sunday.

After Obama announced his plan, Treasury prices fell sharply in volatile trade last week and yields have hit a six-month high, in part due to concerns over the effect the package will have on government debt levels.

If the bill becomes law, it will "adversely affect the federal government budget deficit and debt level," Moody's said.

On Monday, the Democratic-led U.S. Congress moved toward grudging approval of President Obama's deal with Republicans to extend expiring tax cuts, even for the wealthiest Americans.

Last week, Moody's and Fitch Ratings both expressed concerns about the U.S.'s rating longer term, with Moody's fearing the impact if the tax cuts become permanent.

In a market obsessed with the euro sovereign debt crisis, the Moody's note reminded foreign exchange investors about their worries of growing U.S. debt and was a factor pressuring the dollar on Monday.

The cost of insuring U.S. government debt in the credit default swap market was little changed on Monday at around 41 basis points, or $41,000 per year to insure $10 million in debt for five years, according to Markit Intraday.

NEGATIVE IMPACT

A negative outlook would indicate that the rating may be more likely to be cut from the top Aaa rating over the following 12 to 18 months. The United States currently has a stable outlook, indicating a rating change is not anticipated over this time frame.

Moody's estimates the cost of the funding the proposed tax bill, along with unemployment benefits and other policy measures, may be between $700 and $900 billion, which will raise the ratio of government debt to GDP to 72 to 73 percent, depending on the effects on nominal economic growth.

This means that the government's debt relative to revenues will decline much more slowly over the coming two years, to just under 400 percent from 420 percent at the end of fiscal year 2010.

"This is a very high ratio compared with both history and other highly rated sovereigns," Moody's said.

(Reporting by Karen Brettell in New York and Walter Brandimarte in Sao Paulo; Editing by W Simon )