S&P warns of downgrade if no debt deal reached

SYDNEY Fri Jul 15, 2011 8:27am EDT

The U.S. Federal Reserve building is seen in Washington June 29, 2011. REUTERS/Jim Bourg

The U.S. Federal Reserve building is seen in Washington June 29, 2011.

Credit: Reuters/Jim Bourg

SYDNEY (Reuters) - Ratings agency Standard & Poor's has warned there is a one-in-two chance it could cut the United States' prized AAA credit rating if a deal on raising the government's debt ceiling is not agreed soon.

Putting the U.S. on negative watch, S&P warned that it could cut the rating as soon as this month if talks between the White House and Republicans remain stalemated. Any cut would be by one or more notches, it added.

The dollar fell on the news. U.S. Treasuries were largely steady.

John Chambers, the chairman of S&P's sovereign ratings committee, said "this is the time" for the two sides to tackle the country's long-term debt problems.

"If you get a small agreement, that will lead to a downgrade," he told Reuters in an interview.

A downgrade could raise borrowing costs not only for the United States but also for loans that use the Treasury rate as a benchmark.

Some money managers that are restricted to investing only in AAA-rated assets would be forced to dump Treasuries, which could spread disruption through global financial markets.

The S&P warning comes just a day after Moody's Investors Service warned the U.S. may lose its top-notch credit rating in the next few weeks if lawmakers fail to increase the country's legal borrowing limit of $14.3 trillion and the government misses debt payments.

The deadline to raise the ceiling is on August 2.

"Today's CreditWatch placement signals our view that, owing to the dynamics of the political debate on the debt ceiling, there is at least a one-in-two likelihood that we could lower the long-term rating on the U.S. within the next 90 days," the agency said in a statement.

"We have also placed our short-term rating on the U.S. on CreditWatch negative, reflecting our view that the current situation presents such significant uncertainty to the U.S.' creditworthiness," S&P said.

"Further delays in raising the debt ceiling could lead us to conclude that a default is more possible than we previously thought. If so, we could lower the long-term rating on U.S. government this month," S&P said.

U.S. Treasuries reaction was generally muted, perhaps because Moody's had already raised the possibility of a downgrade. Dealers said the market might also be hoping that the pressure from the agencies would jolt U.S. lawmakers into reaching a deal.

As a result, Treasury prices dipped only modestly, lifting 10-year yields to 2.97 percent from 2.92 percent late in New York on Thursday.

The dollar fell against the euro to a session low of $1.42 before pulling back a bit to $1.4180. Dealers said the market was wary of buying the euro ahead of the results of Europe-wide stress tests on 90 banks due later Friday which could force some to seek state aid.

"Markets won't be able to shrug this off completely," said Adrian Foster, head of financial markets research for Asia Pacific at Rabobank International in Hong Kong.

"But the United States is in a different position from other countries. This is not some fiscal reform program that they have to put in place. This is just political machinations.

"It has less of a market impact, because we're programed to think the political machine will come through at the end of the day."

So protracted has been the wrangling over the budget that S&P warned that even if there was a deal done on raising the ceiling, it might still cut the rating if it was not convinced the agreement went far enough to address medium-term debt strains.

"If an agreement is reached, but we do not believe that it likely will stabilize the U.S.' debt dynamics, we, again all other things unchanged, would expect to lower the long-term 'AAA' rating, affirm the 'A-1+' short-term rating, and assign a negative outlook on the long-term rating," said S&P.

The S&P statement showed the need for Congress to act to raise the debt limit, Jeffrey Goldstein, the U.S. Treasury's under secretary for domestic finance, said in a statement.

"Congress must act expeditiously to avoid defaulting on the country's obligations and to enact a credible deficit reduction plan that commands bipartisan support," he said.

(Additional reporting by Walter Brandimarte in New York and Reuters bureaus in Asia; Editing by Balazs Koranyi and Neil Fullick)