(Bloomberg) -- The next US administration “must grapple with widening budget deficits,” warned Moody’s Ratings in a report published Tuesday, nearly a year after it announced a negative outlook for the country’s sovereign credit profile.
“The administration’s tax and spending policies will affect the size of future budget deficits and the expected decline in US fiscal strength, which could have a significant effect on the US sovereign credit profile,” analysts led by Claire Li and William Foster wrote in the report. “These debt dynamics would be increasingly unsustainable and inconsistent with a Aaa rating if no policy actions are taken to course correct.”
Last November, Moody’s lowered the US sovereign outlook to negative from stable while affirming the nation’s rating at Aaa, the highest investment-grade notch.
Moody’s is the only one of the three main credit companies with a top rating on the US after Fitch Ratings downgraded the US government in August 2023 after another debt-ceiling battle in Congress. S&P Global Ratings stripped the US of its top score in 2011 amid that year’s debt-limit crisis.
Moody’s is waiting to see how the new Congress and White House work on shoring up the US fiscal position next year, before making a decision on the sovereign rating outlook, Foster told Bloomberg in a phone interview.
“Over the long term, if fiscal policy does not respond to widening deficits, that would put increasing pressure on the triple A rating,” said Foster. “Fiscal policy is front and center here,” and “that’s why it’s important to focus on fiscal policy response now.”
Negotiations next year in Washington about extending or allowing the 2017 Tax cuts and Jobs Act to expire will be closely watched by Moody’s, said Foster. “We look at that as a potential lever to improve the fiscal outlook with regard to revenues in particular and will be closely watching that.”
Moody’s forecasts that the TCJA will be extended given likely political resistance to an expiration in most post-election government scenarios.
After the races for Congress and the White House in November conclude, Moody’s anticipates “the US government will remain divided, preventing sweeping fiscal reforms by the new administration. As a result, fiscal policy proposals by both candidates will likely require intense bipartisan negotiations and compromise.”
Moody’s has a baseline estimate of 4% for the 10-year yield and Foster said, “if rates remain at current levels or below that, that would be positive and create a bit more space for the cost of debt.
Moody’s highlighted a number of key issues in the report and these include:
- The expiration of the Federal debt limit suspension looms at the start of next year, and Moody’s warned, “political brinkmanship over the debt limit has typically been more disruptive during periods of divided government.”
- A resolution of “the debt limit to finance fiscal deficits and maintain financial market stability will be critical for the US sovereign,” given a backdrop of “around $28 trillion in outstanding federal debt, persistent large fiscal deficits of over 6% of GDP and net interest payments due on federal debt that will likely exceed $1 trillion, (around 3% of GDP) per year.”
- The report said Moody’s “expect that the US government will ultimately resolve any debt limit disputes and continue to pay its obligations on time and in full.”
- While the independence of the Federal Reserve and its interest rate policy has surfaced as an issue during the presidential campaign, Moody’s said they “see little evidence that political considerations factor into the central bank’s “independent decision-making.”
- US Trade policy is seen likely maintaining “a protectionist stance,” and “fuel a shift toward domestic industrial policies.”
- “Social challenges related to immigration will persist,” and tighter polices “could raise labor costs in sectors reliant on foreign-born workers, such as agriculture, healthcare and construction.”
- A divided Congress “could slow the pace of transition to a lower-carbon economy,” however the rating agency said “private sector direction, state mandates and consumer preferences will keep it chugging along.”
(Adds comments from Moody’s Foster starting in fifth paragraph)
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