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U.S. Faces Another Downgrade of its Credit Rating

Moody’s is threatening to downgrade the U.S. prized triple A credit rating if Congress fails to reach a deficit reduction deal. What are the knock-on effects for business and possibly the November election?

The U.S. just received another credit warning, reports the Washington Post. The Associated Press also reported that ”Moody’s Investors Service said Tuesday that it would most likely cut its Aaa rating on United States government debt, probably by one notch, if Washington’s budget negotiations failed. The warning came a little over 13 months after Moody’s rival, Standard & Poor’s, took the drastic step of stripping the United States of its AAA rating on its bonds after partisan wrangling over raising the government’s debt limit led the nation to the brink of default…In its report on Tuesday, Moody’s said it was concerned that the partisan stalemate would continue, saying it was difficult to predict when Congress would reach a deal on the budget.”

The Financial Times’ Robin Harding and James Politi reported that the downgrade
is likely “to feed into election campaign concerns over the state of the economy and lift Republican hopes of a boost for Barack Obama’s challenger, Mitt Romney, by focusing attention on the size of the national debt.” It also adds pressure on lawmakers in Congress to prevent the economy from going over the so-called “fiscal cliff” – a series of tax increases and automatic spending cuts due in early January. Even this may not be enough to prevent a downgrade, and that a broader agreement to shrink America’s debt pile over the medium term would be required.

For its part Moody’s added that it may cut the country’s rating to Aa1 if the results were not satisfactory. “What we’re looking for is a downward trajectory of the debt over the medium term,” said Steven Hess, lead analyst for the US sovereign rating at Moody’s in New York, according to FT reports.

Many businesses would face more onerous borrowing hurdles if Moody’s downgrade, on top of S&P’s controversial move in August 2011, should follow. It would further undermine the standing of US Treasury securities as the world’s most safe, risk-free asset. It would also weigh heavily on bond prices.

Negotiations on the fiscal cliff are only expected to start in earnest once the new balance of power in Washington is determined by the election. At around the same time it will also be necessary to raise again the limit on federal government borrowing.

But the Moody’s warning underscored that a deal will have to be accompanied, or followed shortly after, by a broader agreement to reduce medium-term debt levels, involving greater tax revenues, cuts to entitlement programs or both, if investors are to accept it as credible.




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