NEW YORK Moody's Investors Service warned on Thursday that lack of U.S. government action on the budget deficit increases the likelihood of a negative outlook on the country's top AAA credit rating.
The Moody's report, which came hours after a downgrade of Japan by Standard & Poor's and an IMF warning on growing budget deficits in both countries, reiterated previous comments made by the agency late last year.
Moody's had said in December that the extension of Bush-era tax cuts would add to the likelihood of a negative outlook on the U.S. rating in the next two years.
Lower debt ratings typically push up a country's borrowing costs. A negative outlook makes a rating downgrade more likely in the next 12 to 18 months.
In Thursday's report, Moody's provided more details about the risks to U.S. ratings. It expressed concern about the new configuration of the U.S. Congress, saying it may reduce the chances of an agreement to rein in the deficit.
The Republicans won majority control of the U.S. House of Representatives in the November elections, but the Democrats continue to hold the majority in the Senate.
Moody's also worried that Congress may fail to consider and pass into law some of the deficit-reducing measures proposed by the National Commission on Fiscal Responsibility and Reform, a panel mandated by President Barack Obama to find ways to tackle the deficit.
"Recent trends in and the outlook for government financial metrics in particular indicate that the level of risk (to the U.S. rating), while still small, is rising and likely to continue to rise in the next several years," Moody's said in the report.
"Although no rating action is contemplated at this time, the time frame for possible future actions appears to be shortening, and the probability of assigning a negative outlook in the coming two years is rising," it added.
The purpose of the report was to provide more details on the agency's view on the U.S. credit-worthiness and not to address any recent developments that could impact the ratings, Moody's analyst Steven Hess told Reuters in an interview.
For Moody's, the next piece of relevant information for U.S. ratings will be the presentation of the federal budget next month "because it's going to show the proposals on the part of the administration on what to do" to address the nation's deficit problem, Hess said.
Prices for U.S. Treasuries were unmoved on the report, with benchmark 10-year notes remaining 6/32 higher on the day, yielding 3.39 percent.
Long-term U.S. rates are expected to rise toward 5 percent in the next three years but average less than that, Moody's said in the report. At those levels, the agency would remain comfortable with the U.S. debt affordability, Hess said.
"Our expectation and our forecasts for debt affordability include both an increase in the debt and an increase in the interest rate such as the one that we described -- going up but remaining less than 5 percent," he said.
Some traders said the report, which broke late on Thursday, could still seep into markets and pull bond prices down on Friday.
"When you have punishing news like this from Moody's and other rating agencies, it will clearly leave a negative impression on Treasuries. You could see a rise (in) yields tomorrow," said Todd Schoenberger, managing director at LandColt Trading Inc. in Wilmington, Delaware.
(Additional reporting by Richard Leong; Editing by Leslie Adler and carol Bishopric)