UPDATE 1-S&P says 50-50 chance of U.S. downgrade

Thu Jul 21, 2011 10:22am EDT

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NEW YORK, July 21 (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 Aug. 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 US30YT=RR briefly falling a full point in price. (Reporting by Emily Flitter and Daniel Bases; Editing by Theodore d'Afflisio)

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Comments (2)
ojfl wrote:
That makes much more sense. I never understood this fixation of the media on the debt ceiling without any changes to the fiscal trajectory of the country. I never saw the ratings agencies would just sit idly while the government spends itself into oblivion and would not tell investors about the risks associated with that. It would be irresponsible of the agencies NOT to downgrade the US. Now I feel relieved the world is still spinning.

Jul 21, 2011 3:45pm EDT  --  Report as abuse
pebbles14 wrote:

No tax increases. No “Mini-Deal.” No Pontius Pilate. JUST CUT SPENDING! Hear the American People when we say this: They told us Chevy trucks were unsafe, only to find out they had rigged the gas tanks with sky rockets; they told us Food Lion meat was tainted only to find out they had planted bad meat to help a union campaign against the food chain; they told us George W. Bush had tried to avoid active duty in the military only to find that the “documents” “proving” this were fake; they told us that if we spent 1 TRILLION dollars in so called “stimulus” money that our roads and bridges would get fixed and unemployment would go no higher than 8%; when Enron collapsed they told us the Sarbanes-Oxley law would prevent another crash but in 2008 there was another crash; they told us that we had to spend billions of dollars on TARP or the entire banking system would collapse and yet the “derivative” system that supposedly caused it is still in place; they told us that the era of big government was over but since 1962 the federal govt. has gotten 14 times bigger and welfare spending has increased by 13 times; they told us Obama’s socialized medicine scheme would reduce costs but premiums have already soared and the CBO now says it will cost $2 trillion more; far left enviro-doomsayers like Paul Ehrlich said that the world would end and it would happen by the year 2000 due to a population boom; before that he said by 1980, “all important animal life in the sea will be extinct”*; we were told that alar, sprayed on apples, would cause cancer but were not told that test results were based on drinking 5000 GALLONS of apple juice per day; they have told us spending more money for education (and more government/union control) will make our kids smarter but test scores have declined for decades; they tell us there is no possible way government spending can be cut but spend billions of dollars studying shrimp on tread mills;** We were told that the Obama-Boehner Budget deal would cut $38.5 billion but then learned that it only “cut” $352 million and that the debt jumped $54 billion in the 8 days preceding the deal***; Democrats tell us if we don’t raise the debt ceiling we’re racists and yet Every Dem Senator including Obama voted against raising debt limit in 2006; Now Obama’s tax cheat, Secretary of the Treasury Geithner, is telling us that if the debt ceiling is not raised so the federal government can borrow trillions more dollars the world is going to end….And we’re supposed to believe them now?!!!! HOW FRAKIN’ STUPID THEY THINK WE ARE?!!
**New York Post: Profits of Doom

Jul 21, 2011 10:44pm EDT  --  Report as abuse
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