Credit-Rating Agencies Don't Worry About Debt Ceiling

The biggest tail risk for the markets and the economy these days is the Congressional showdown over raising the United States’ debt ceiling. A default would deliver a major shock to investor confidence, raise borrowing costs across the economy, and result in credit-rating downgrades for U.S. debt.

Here's Mark Zandi, chief economist at Moody’s Analytics—the firm’s research division, which is separate from its credit-rating business—in a recent report:

A default would be a catastrophic blow to the nascent economic recovery from the Covid-19 pandemic. Global financial markets and the economy would be upended, and even if resolved quickly, Americans would pay for this default for generations, as global investors would rightly believe that the federal government’s finances have been politicized and that a time may come when they would not be paid what they are owed when owed it.

Moody's currently has a Aaa rating, its highest, on U.S. sovereign debt. It's what allows investors to consider Treasuries "risk free" for all intents and purposes.

The debt ceiling limits how much the U.S. Treasury can borrow to finance the federal government’s spending—currently some $28.4 trillion—in excess of tax revenues. Treasury Secretary Janet Yellen has designated Oct. 18 as the date when her department runs out of “extraordinary measures” it can take to keep meeting the government’s obligations without issuing more debt. Congress needs to raise or suspend the debt ceiling first to make that possible.

If Oct. 18 comes and goes without a resolution, the result would be an unprecedented U.S. sovereign debt default. Normally an uneventful affair, the current fracas over raising the debt limit echoes fights in 2011 and 2013. In 2011, Congress acted on the debt ceiling just two days before the Treasury said it would be unable to pay its bills. That was close enough to a default that Standard & Poor’s, one of the three major credit-ratings firms, downgraded the U.S. federal government’s creditworthiness to AA+, from AAA, in the aftermath. In 2013, Fitch put U.S. government debt on a negative watch, ultimately keeping its rating at AAA.

S&P continues to have a AA+ rating and stable outlook on U.S. sovereign debt today. For now, the credit rating firm isn’t expecting the U.S. to actually default this month, just for it to get close to the brink.

Here's Joydeep Mukherji, Americas sovereign ratings analyst at S&P, in a bulletin last week:

The uncertainties surrounding periodic political impasses over the debt ceiling and avoiding a shutdown of the government can hurt public confidence and potentially pose serious implications for domestic and global financial markets. However, they can also be quickly resolved by the country's political leadership, as has been the case thus far, as these uncertainties reflect political maneuvering and calculations rather than underlying economic difficulties.

As a result, Mukherji is confident that Congress will pull itself together and address the debt ceiling on time. That warrants a stable rating, unless politicians prove S&P wrong.

Fitch recently warned that even if the Treasury could continue paying timely interest on its debt beyond its “X-date” by delaying other payments, that would still undermine its current AAA rating. The firm returned to its negative watch on U.S. debt in July 2020.

“The economic impact of debt prioritization and the potential damage to investor confidence in the full faith and credit of the U.S. (which enables its 'AAA' rating to tolerate such high public debt) may not be compatible with an 'AAA' rating,” wrote Fitch’s Charles Seville, senior director for sovereigns, in a note on Friday.

But like S&P, Fitch sees the current Congressional standoff over the debt limit being resolved in time to avoid a default.

A Senate vote to increase the debt limit could come as soon as tomorrow. Barron's Sabrina Escobar has more on the current standoff in Washington D.C. here.