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If Congress Blocks Sequester, U.S. Rating Cut Could Follow If Congress Blocks Sequester, U.S. Rating Cut Could Follow

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If Congress Blocks Sequester, U.S. Rating Cut Could Follow


Standard and Poor's headquarters.

The long-term outlook for restoring the United States' AAA credit rating suffered a significant setback on Monday with the super committee’s striking failure to take even a modest step toward its mandated goal of reducing the deficit by $1.2 trillion over the next decade.

Although no immediate downgrades were expected, pernicious partisanship and stalemate were paving the path to further action by the ratings agencies next year, analysts said, as Washington’s inability to responsibly manage the nation’s deteriorating fiscal position undermines investor confidence.


(RELATED: Obama: I Will Veto Any Effort to Undo Automatic Cuts)

From National Journal:

SUPER COMMITTEE Super Committee Failure Won’t Hurt the Economy for Another Year

CARTOONSCan Congress Change Its Ways?

Statement from Co-Chairs of the Joint Select Committee on Deficit Reduction

Now, Wall Street will watch as Congress prepares for a new deficit fight waged by lawmakers who want to adjust the automatic spending cuts written into law as a backup to the super committee and those who will push to have the Bush-era tax cuts extended again next year. And here, congressional inaction would be cheered by budget hawks, and ratings agencies, for reducing the deficit more than some botched, half-baked super-committee deal could have.


“There are reasons to be optimistic,” said Mark Zandi, the chief economist for Moody’s Analytics, who does not speak for the ratings firm. He said that if the Bush tax cuts expire as scheduled under current law at the end of 2012, the failure would contribute a sizable chunk of savings—$3.8 trillion over 10 years.

“If policymakers do nothing, we’ve achieved the goal of fiscal sustainability,” he said.

(RELATED: Battle Over Sequester Brewing in Congress)

But should Congress tinker with the automatic cuts—the “sequestration”—the United States could see its rating cut again next year.


“We expect the caps on discretionary spending as laid out in the Budget Control Act of 2011 to remain in force,” Standard & Poor’s, the single agency to strip the United States of the top-tier rating this summer, said after the super committee announced its failure. “If these limits are eased, downward pressure on the ratings could build.”

(RELATED: Super Committee Goes Out With a Whimper)

The economic outlook, which the rating agencies also will take into account, varies greatly depending on the short-versus-long-term fiscal policy view. Several tax provisions, including the payroll tax cut and unemployment benefits, are set to expire at the end of 2011, and some economic forecasters, such as Macroeconomic Advisers, have already baked that into their models.

But longer term, analysts warn of greater uncertainty and more economic volatility, especially as Congress has until 2013 to tweak sequestration.

“The S&P’s negative outlook and downgrade to AA+ in August was all about the political dysfunction, the inability to raise revenues, the outlook that it might linger until 2013 and that the country might not be willing or able to make changes in time to sort of head off this meteor heading towards us,” said Charles Gabriel, an analyst with Capital Alpha Partners.

“I had thought that the leaders would be more engaged on the stretch and that the markets would have sent a more discreet signal to tighten the sphincters and make these guys do this,” he said.

The super committee's failure was broadly anticipated and factored into both the political and economic equation. But circumventing previously agreed-upon savings, such as the defense cuts, will unnerve markets as investors’ expectations of another downgrade rise.

Chris Low, the chief economist with First Horizon National's FTN Financial, said that markets believed Moody’s Investor Service and Fitch Ratings could be compelled to match S&P’s controversial August downgrade if Congress succeeds in preventing the savings of at least $1.2 trillion from going into effect.

“Moody’s has already said it will revisit the rating partly because it hinges on the automatic cuts and whether those go through,” Low said. “If Congress is successful in either preventing those cuts, or if those cuts aren’t real, that could be an issue.”

Moody’s Investor’s Service declined to comment on how the super committee’s result would affect its future ratings calculations.

But Fitch Ratings said the super committee's impasse increased the liklihood that the agency would lower its U.S. credit rating outlook to negative after it completes a review at the end of the month. That action would signal a greater than 50 percent chance of Fitch downgrading the United States in the next two years.

“The announcement today that the super committee was unable to reach agreement on at least $1.2 trillion of deficit-reduction measures underscores the challenge of securing the political consensus on how to reduce the federal budget deficit and place U.S. public finances on a sustainable path over the medium-term,” the agency said in a press release.

Fitch will conclude its review of the U.S. rating by the end of November.


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