Moody's expects to affirm U.S. rating

NEW YORK Fri Jul 29, 2011 6:38pm EDT

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NEW YORK (Reuters) - Moody's Investor's Service expects to maintain the United States' top-notch rating for now, despite the "limited magnitude" of the deficit reduction plans being discussed in Washington.

But Moody's on Friday warned that affirmation of its Aaa credit rating for the United States will likely come with a negative outlook, meaning it would not downgrade the rating immediately but could do so in the medium term.

The report from Moody's came four days before the United States hits its debt limit. In Washington, Republicans pressed ahead with a deficit plan that cannot pass Congress, and President Barack Obama told lawmakers to stop wasting time and find a way "out of this mess."

Moody's said its expectation on its rating action is based on the likely scenario that the government will continue to honor bond payments even if lawmakers fail to raise the debt ceiling before August 2 -- the date when the Treasury is expected to run out of cash to pay all of its obligations.

"If the debt limit is not raised before August 2, we believe that the Treasury would give priority to debt service payments and could thus postpone a potential debt default for a number of days," Moody's said in its report.

"Revenues would be more than adequate for some period of time to meet those payments, although other outlays would be severely reduced as a result."

The ratings agency warned, however, that a debt default would likely lead to a rating downgrade even if it was "swiftly cured and investors suffered no permanent losses."

Lawmakers in Washington were set to work through the weekend, with a plan by Republican House of Representatives Speaker John Boehner expected to die in the Democratic-controlled Senate on Friday night.

Wall Street on Friday ended its worst week in a year, and one equity strategist said the stock market's direction on Monday will rely on the weekend's outcome.

"It exclusively is a function of what does Congress do over the next 48 hours," said Phil Orlando, chief equity market strategist at Federated Investors. "If Speaker Boehner is able to get a deal through over the next two days, we trade higher. If we get nothing constructive and a series of more dueling press conferences we probably open lower.

"The ball is in their court. They know what they need to do," he added.

Moody's noted that the first interest payment of $31 billion on U.S. Treasury debt is not due until August 15.

"This is the first date that a default on bonds could occur," the report said, highlighting that this year August is the month when the ratio of interest payments to incoming revenues is highest.

There is less potential for a default surrounding the payment on maturing Treasury bills, notes and bonds, Moody's says because that would assume they could not be refinanced.

The first T-bill maturity date after August 2 is August 4, when $59 billion in T-bills mature.

"Should the Treasury be unable to find buyers for an equivalent amount, a default might occur. This scenario seems extremely unlikely, given the role of the T-bill market in both domestic and global financial markets," Moody's said.

(Reporting by Walter Brandimarte and Daniel Bases; Editing by Leslie Adler)