S&P says 50-50 chance of U.S. downgrade

NEW YORK Thu Jul 21, 2011 2:55pm EDT

A demonstrator holds placards to protest U.S. debt in front of the Capitol in Washington, July 18, 2011. REUTERS/Kevin Lamarque

A demonstrator holds placards to protest U.S. debt in front of the Capitol in Washington, July 18, 2011.

Credit: Reuters/Kevin Lamarque

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NEW YORK (Reuters) - Standard & Poor's reiterated on Thursday it sees a real risk that future U.S. government deficits may meaningfully miss discussed targets and that there is a 50-50 chance the U.S. AAA credit rating could be cut within three months, perhaps as soon as August.

The deficit reduction debate is coming up against an August 2 deadline when the $14.3 trillion limit on America's borrowing capacity is exhausted, putting in jeopardy payments on U.S. Treasury debt as well as paychecks for federal employees and soldiers.

If an agreement is reached to raise the debt ceiling but nothing meaningful is done in terms of deficit reduction, the U.S. would likely have its rating cut to the AA category, S&P said.

"While banks and broker-dealers wouldn't likely suffer any immediate ratings downgrades, we would downgrade the debt of Fannie Mae, Freddie Mac, the 'AAA' rated Federal Home Loan Banks, and the 'AAA' rated Federal Farm Credit System Banks to correspond with the U.S. sovereign rating," S&P said in its report.

"We would also lower the ratings on 'AAA' rated U.S. insurance groups, as per our criteria that correlates insurers' and sovereigns' ratings," the firm said.

However, S&P said it sees a failure to reach an agreement on raising the debt ceiling and reducing deficits as the least likely scenario, adding that in such a case the global financial markets would be in turmoil and "likely shove the U.S. economy back into recession."

In such a hypothetical case, it envisages the U.S. Treasury curtailing spending sharply and the U.S. Federal Reserve launching another round of quantitative easing to help prop up the economy.

"Under this scenario, we expect that interest rates could rise--say, 50 bps on short-term rates and double that on the long end--though this may depend on whether Treasuries would lose their status as the safe haven that investors have historically perceived them to be, or whether physical assets such as gold would benefit from such a flight to quality," S&P said.

It added that either way, corporate borrowers would likely see yield spreads widen while equity markets and the U.S. dollar would likely suffer.

The outline of potential knock-on effects of a U.S. credit rating downgrade were first reported by Market News International.

As Aug 2 approaches, the U.S. Treasury market has grown sensitive to news on the potential for the U.S. to actually default or, even if Washington can reach a deal to avoid default, a downgrade based on longer-term fiscal conditions.

The S&P's latest comments led to selling in longer-dated Treasuries, with the 30-year bond briefly falling a full point in price.

(Reporting by Emily Flitter and Daniel Bases; Editing by Theodore d'Afflisio)

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Comments (9)
breezinthru wrote:
Is the whole world coming unhinged?

This headline predicts a 50% likelihood of downgrading the credit status of the United States of America and on the right margin of this page, the Dow is up 115 points.

What kind of news would it take for the financial markets to embark on a steep decline… a report of a limited nuclear exchange?

Jul 21, 2011 12:21pm EDT  --  Report as abuse
truetoearth wrote:
breezinthru, its not their money they are gambling with, its ours.

Jul 21, 2011 12:33pm EDT  --  Report as abuse
@breezinthru. At first glance the bad news credit status headline and the DOW being up seem contradictory, but the DOW is not perhaps what you think it is. The DOW is a mix of stocks used as an indices of investment activity. Interesting thing though, when a stock starts to perform poorly the DOW takes it off the index and adds a good performer, so it always looks like things are just fine. In short, the blend of stocks today are not the same ones from 10 years ago.

Also look at what the stocks are. As a country we need companies and stocks which employ hard working middle class citizens in production and manufacturing, but these DOW stocks represent companies which do neither. Facebook is “worth” billions, but has zero invested in the production of anything, and has less than 2,000 employees. New to the exchange Groupon is supposed to be “worth” 20 billion, and is nothing but a coupon service again, employing 3-4,000 and producing nothing. Neither company has employed one middle class person, nor invested one cent in production of anything, but that’s where “investors” are putting their money, and thats a systemic problem in America which has kept unemployment high, causing defaults in housing, and weakening our banking system. Look at all the financial companies which are listed. What do they produce? Nothing. This “quick buck” approach regarding investment is why the middle class has been decimated, and a primary reason as to why jobs have moved overseas. If this fundamental problem in our society is not fixed soon, the DOW will move ever higher, even as the economy gets worse because the unemployment level can never improve.

Jul 21, 2011 12:57pm EDT  --  Report as abuse
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