Uncertainties Loom Over U.S. Credit Outlook Despite Debt Ceiling Agreement

Indian stock market

Date: May 31, 2023

Place- New Delhi, India

News of a debt ceiling agreement still leaves uncertainties on the U.S. credit outlook, analysts said, in addition to the immediate risk that Congress may not pass the proposed deal before the country runs out of cash.

Democratic President Joe Biden and the top Republican in Congress, House Speaker Kevin McCarthy, have predicted they will get enough votes to pass the deal into law before Monday when the U.S. Treasury Department says it will not have enough money to cover its obligations.

Reflecting investor optimism about passage, the cost of insuring exposure to a U.S. debt default dropped on Tuesday, but some concerns remained because of the tight timeline and opposition from some lawmakers.

“There remain potential hurdles in the process and the saber-rattling has continued,” BMO Capital Markets analysts said in a note. “We’re content to characterize the vocal opposition as politics as usual and assume the process won’t break down before the finish line,” they said.

Investors are also bracing for potential rating actions even if a default is averted.

Last week, credit rating agency Fitch placed its “AAA” rating of U.S. sovereign debt on watch for a possible downgrade, citing downside risks including political brinkmanship and a growing debt burden.

“Despite positive progress towards a deal, we still view it as likely that Fitch will downgrade the U.S. credit rating,” Raymond James analysts Ed Mills and Alex Anderson said in a note.

In a previous debt ceiling crisis in 2011, rating agency Standard & Poor’s cut the U.S. top ‘AAA’ rating by one notch a few days after a debt ceiling deal, citing political polarization and insufficient steps to right the nation’s fiscal outlook. Its rating is still ‘AA-plus’ – it’s the second highest.

“Even if a U.S. default is averted, a rating downgrade could still happen,” Vishwanath Tirupattur, a strategist at Morgan Stanley, said in a research note on Sunday. The loss of a top rating from a second agency could be problematic for portfolios requiring AAA average ratings for the securities they hold, he said.

Spokespeople for Fitch, Moody’s, and S&P Global Ratings did not immediately respond to requests for comment.

Some also fear a debt ceiling resolution could only provide short-term relief to markets because the U.S. Treasury is expected to quickly refill its account with bond sales, sucking out hundreds of billions of dollars of cash from the market.

“I could foresee liquidity becoming an issue even if the debt ceiling negotiations come to a resolution, particularly if rating agencies continue to sour on how the situations and negotiations were handled,” said U.S Bank’s head of investment-grade trading Blair Shwedo.

While there is hope for a resolution, the uncertainty surrounding the U.S. credit outlook persists. The debt ceiling agreement, if passed in time, may avert a default, but the potential for a rating downgrade remains a concern. Last week, Fitch placed the U.S. sovereign debt rating on watch for a possible downgrade due to political brinkmanship and a growing debt burden. Should the U.S. credit rating be downgraded, it could have implications for portfolios requiring high average ratings for the securities they hold.

It is worth noting that even if the debt ceiling crisis is resolved, there are concerns that it may only offer temporary relief to the markets. The U.S. Treasury is expected to quickly replenish its accounts through bond sales, potentially draining hundreds of billions of dollars from the market. This liquidity issue could be exacerbated if rating agencies continue to express dissatisfaction with the handling of the situation and negotiations.

Read more details about the Debt Ceiling deal here

Disclaimer: This article is prepared by CurrencyVeda as an information provider and does not constitute financial advice. Readers are advised to consult with a professional financial advisor before making any investment decisions.