Fitch Ratings has affirmed the United States of America’s Long-Term Foreign-Currency Issuer Default Rating (IDR) at ‘AAA’, and has revised the Rating Outlook to Stable from Negative.
A full list of rating actions follows at the end of this rating action commentary.
KEY RATING DRIVERS
Outlook Revised to Stable: The Outlook Revision to Stable reflects the improved near-term government debt dynamics driven by the strong post-pandemic economic recovery and buoyant government revenues, which Fitch expects to grow by 19% in 2022, propelled by strong personal and corporate income taxes.
Fitch has substantially improved its fiscal and debt projections since its last review. Fitch now forecasts a decline in the general government debt ratio to 113% of GDP at YE 2022, from 118% in 2021 (and a peak of 123% in 2020) before beginning to rise again at a gradual pace in 2024.
Exceptional Credit Strengths: The U.S. sovereign rating is supported by structural strengths that include the size of the economy, high per capita income, and a dynamic business environment. The U.S. benefits from issuing the U.S. dollar, the world’s preeminent reserve currency, and from the associated extraordinary financing flexibility, which has been highlighted once again by developments since March 2020. Fitch considers U.S. debt tolerance to be higher than that of other ‘AAA’ sovereigns.
Better than Expected Fiscal Outturn: A stronger-than-expected economic recovery has led public finances to outperform Fitch’s expectations at the last review, generating higher tax revenues while most pandemic-related spending has wound down. Fitch forecasts a general government deficit at 5% of GDP, down from an estimated 10.2% of GDP in 2021. State and local governments continue to perform well, and could result in an even lower general government outturn.
Steady Fiscal Baseline: Fitch expects a continued narrowing of the primary budget deficit in 2023-2024, but a rising interest burden will keep the deficits at 5.2% of GDP. A relative tightening in fiscal policy as pandemic relief spending continues to roll off is the key feature of Fitch’s baseline fiscal forecasts. Fitch has assumed that spending is in line with the CBO (current-law) baseline. A simple majority of 51 (Democratic) votes in the Senate could pass a further bill by reconciliation that would include more spending likely focusing on prescription drug pricing reform, offset by revenue measures.
Additionally, the U.S. Innovation and Competition Act (USICA) has significant bi-partisan support; and therefore, could gain approval before the November mid-term elections. In addition to other items, it calls for USD50 billion to stimulate U.S. semiconductor innovation and production and USD50 billion for R&D, which is not included in Fitch’s baseline.
Debt to GDP to Fall in 2022: Fitch expects the general government debt/GDP ratio to fall to 113% in 2022 based on nominal GDP growth of 9.5%. Debt dynamics point to broad stabilization of the debt ratio around the 113% of GDP level in 2023, followed by a shallow increase from 2024 onwards. Between 2022 and 2032 the CBO June 2022 baseline includes a 2.0pp of GDP rise in spending on healthcare and social security, linked to demographics and healthcare costs.
Higher Post-Pandemic Debt Level: Current debt levels are over 10pp of GDP higher than pre-pandemic, representing an additional burden on public finances over an indefinite horizon. Yet at current borrowing costs, debt service is just 6% of revenues (albeit much higher than ‘AAA’ rated peers), a similar level to the post-2008 average.
Interest rates have risen significantly over the last six months with the 10-year Treasury yield at close to 3% and are expected to rise over the coming year as Fed monetary policy stimulus is unwound. Under a scenario where real interest rates rose by 200 basis points compared with Fitch’s baseline (which is steeper than that of the CBO), the debt ratio would rise by 9pp of GDP by YE 2026.
Debt Limit Tail Risk: In late 2021, Congress raised the debt-ceiling limit to USD31.4 trillion, after the government came close to exhausting the scope of extraordinary measures used to meet its obligations without incurring new debt (the X-date). Independent estimates show that the better than expected growth in tax revenues in 2022 could push the next X date until the second half of 2023. Failure to raise the debt limit in time to prevent a default (in the absence of a formal way of prioritizing debt service) is a meaningful but remote tail risk to the rating.
Significant Economic Slowdown in 2023: Fitch expects U.S. growth of 2.9% in 2022 driven by consumption underpinned by continued labor market strength with solid growth in both employment and nominal wages (up 6.6% yoy in May). The service sector also continues to rebound. However, a tightening of monetary policy, which has already begun to hit interest rate sensitive sectors such as housing (average 30-year mortgage rates have risen by nearly 270 basis points to date to 5.8%), will lead to a slowdown. High inflation will also begin to impact consumer spending. Fitch expects the economy will slow in 2H22 and over the course of 2023, with below trend growth of 1.5% in 2023 and 1.3% in 2024.
High Inflation: Headline consumer price inflation rose to 8.6% yoy in May, the highest rate since the early 1980s, driven by service inflation and a jump in food price inflation (up 10.1% yoy). Russia’s invasion of Ukraine has increased commodity prices, especially oil prices, while the lockdowns in China have exacerbated supply chain issues and pressured core goods prices. Fitch’s 2022 and 2023 annual average inflation forecasts have risen to 7.8% and 3.7%, respectively.
Furthermore, tight labor market conditions are putting upward pressure on nominal wage inflation, increasing the risk that wage-price inflationary spiral could gain momentum. The U.S. labor participation rate remains below pre-pandemic levels, while job vacancies have hit record highs.
Monetary Tightening: Fitch now expects the U.S. Federal Reserve to hike rates at a more aggressive pace to restrictive levels after hiking rates by 75 basis points at its June meeting. The agency expects the Fed to hike rates at each of the next three meetings to 3% by YE 2022. Fitch expects further hikes in 1Q23, reaching 3.5% and remaining at this level through 2024.
In addition to policy rate increases, the Fed began to unwind its nearly USD9 trillion balance sheet in June by allowing its bonds to mature and not reinvesting the principal payments received above an adjustable cap. The Fed announced a USD47.5 billion pace of reduction per month initially (USD 30 billion for Treasuries and USD17.5 billion for mortgage backed securities) before doubling the monthly amounts to USD60 billion and USD35 billion respectively after the first three months.
Deterioration in Governance: Governance is a weakness relative to the ‘AAA’ median, and the future direction of the rating is sensitive to the direction it takes. The failure of the former president to concede the election and the events surrounding the certification of the results of the presidential election in Congress in January 2021, have no recent parallels in other very highly rated sovereigns. These developments underline an ongoing political polarization with increased risks of partisanship heightening the difficulty in formulating policy and passing laws in Congress.
ESG – Governance: The United States has an ESG Relevance Score (RS) of ‘5’ for Political Stability and Rights and ‘5[+]’ for the Rule of Law, Institutional and Regulatory Quality and Control of Corruption. These scores reflect the high weight that the World Bank Governance Indicators (WBGI) have in Fitch’s proprietary Sovereign Rating Model. The United States has a high WBGI ranking at 77.5, reflecting well established rights for participation in the political process, strong institutional capacity, effective rule of law and a low level of corruption, although its ranking for political stability has dropped below the 50th percentile.
