Debt deal doesn't dispel downgrade fear

NEW YORK Tue Aug 2, 2011 12:40pm EDT

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NEW YORK (Reuters) - Investors fear the United States may be headed for a credit ratings downgrade even if the Senate approves a $2.1 trillion package of spending cuts later on Tuesday.

Though the bill removes the threat of imminent default by raising the national debt limit enough to last until 2013, its cuts are only about half the $4 trillion in savings that ratings agencies Standard & Poor's and Moody's have said would be enough to confirm the country's triple-A rating with a stable outlook.

Adding a sense of immediacy to downgrade anxieties, S&P said in mid-July there was a 50-50 chance it would cut U.S. ratings in the next three months if lawmakers failed to craft a meaningful plan to cut the nation's deficit.

S&P could downgrade U.S. ratings soon after the bill is signed by President Barack Obama, given that the agency will have all the information it needs to make a decision.

Such a move would likely cause both U.S. Treasury and stock prices to fall.

"A lot of people are very concerned about the potential for a downgrade," said Robert Pavlik, chief market strategist at Banyan Partners LLC in New York.

The House approved the bill on Monday and Obama is expected to sign once it passes through the Senate.

Adding to the cloud of uncertainty, the other major ratings agencies, Fitch Ratings and Moody's Investors Service, have been less severe than S&P and will await further developments before deciding whether to downgrade the United States.

Moody's has also said the United States could keep its top-notch credit rating for now, despite the "limited magnitude" of the deficit-reduction plans being discussed in Washington.

But it did warn in a report that the confirmation of the Aaa credit rating is likely to come with a negative outlook, meaning there is a risk of a downgrade in the medium term.

Even though markets have been anticipating a downgrade by S&P, there is a huge amount of uncertainty about how exactly investors would react to news U.S. Treasuries were no longer rated among the world's safest assets.

"There's been no clear direction, given about how these issues will ultimately be resolved, which is another reason the market is concerned," said Kenneth Buckfire, chief executive officer at Miller Buckfire in New York.

A downgrade could add up to 0.7 percentage points to Treasury debt yields over time, or $100 billion in lost value, members of a U.S. securities industry trade group have said.

That said, United States' bonds are in constant demand because financial markets rely on them a for wide range of transactions for everything from stashing savings to backing loans.

Dismal data pointing to a slowing economy and a spreading sovereign debt crisis in Europe will also keep demand strong for U.S. Treasury debt.

In the latest economic data, U.S. consumer spending fell unexpectedly in June to post the first decline in nearly two years as incomes barely rose, the government reported.

A weak reading on manufacturing on Monday underscored growing concerns about the economy's strength.

(Additional reporting by Ryan Vlastelica; Editing by Burton Frierson and Andrew Hay)