Moody's expects to affirm U.S. rating, negative outlook

NEW YORK Fri Jul 29, 2011 8:12pm EDT

NEW YORK (Reuters) - The United States will likely keep its top-notch credit rating from Moody's for now, despite the "limited magnitude" of the deficit reduction plans being discussed in Washington, the ratings agency said on Friday.

But Moody's warned in a report that the confirmation of the Aaa credit will likely come with a negative outlook, meaning there is a risk of a downgrade in the medium term.

That decision will depend on the U.S. economic performance in 2012 and prospects for future deficit-reduction measures, Moody's analyst Steven Hess said.

"If we're convinced that the economy takes off in 2012 and shows very strong growth, that makes the whole process of fiscal consolidation somewhat easier," Hess told Reuters in an interview.

The report from Moody's came four days before the United States says it will run out of cash to pay all of its bills.

In Washington, the House passed a deficit plan that likely will die in the Senate, and President Barack Obama told lawmakers before the vote to stop wasting time and find a way "out of this mess."

Moody's issued the report to clarify its position on the U.S. debt situation, its Chief Risk Officer Richard Cantor said in the same interview.

"Sometimes there is confusion and all the ratings agencies are grouped together," he said.

Standard & Poor's has threatened to cut U.S. ratings in the next few months if the lawmakers fail to come up with a meaningful plan to cut the nation's deficit.

Both agencies seem to agree that deficit-reduction measures of around $4 trillion would be enough for the United States to avoid a rating downgrade.

The difference is that, while S&P has indicated it may downgrade the United States by mid-October if it doesn't see a meaningful deficit-reduction plan in place now, Moody's is willing to give the government more time before making that decision.

PRIORITIZING DEBT PAYMENTS

Moody's expects the government will continue to honor bond payments even if lawmakers fail to raise the debt ceiling before August 2.

"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 recently-passed 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."

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 the highest.

The agency sees less chance of a default on August 4, when T-bills worth $59 billion mature because it is unlikely that the Treasury would not be able to find buyers to refinance them.

"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.

(Editing by Carol Bishopric)

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