Moody’s says U.S. faces credit rating cut

Moody’s Investors Service said it may join Standard & Poor’s in downgrading the U.S.’s credit rating unless Congress next year reduces the percentage of debt- to-gross-domestic-product during budget negotiations.

The U.S. economy will probably tip into recession next year if lawmakers and President Barack Obama can’t break an impasse over the federal budget and if George W. Bush-era tax cuts expire in what’s become known as the “fiscal cliff,” according to a report by the nonpartisan Congressional Budget Office published on Aug. 22.

The rating would likely be cut to Aa1 from Aaa if an agreement on the debt ratio isn’t reached, Moody’s said in a statement today (Sept. 11).

Moody’s put the rating under review with a negative outlook in August 2011, when the U.S. pushed back a decision on spending and raised its so-called the debt ceiling after months of political wrangling. S&P cut its rating to AA+ that month, blaming the nation’s political process. Treasuries rallied as investors ignored the reduction, with the yield on the benchmark 10-year note since declining to record lows and drawing the ire of investors such as Warren Buffett, the biggest shareholder of Moody’s, who said after the S&P decision that the U.S. should be “quadruple-A.”

“At some point, we might see the market demand a higher yield premium to own Treasuries, but I don’t think that’s the case now as this is just a shot across the bow,” said Jack McIntyre, a money manager in Philadelphia at Brandywine Global Investment, which oversees $30 billion of debt. “It’s hard to find a bond market that has the depth of liquidity that Treasuries do.”

McIntyre said his firm has reduced its Treasury holdings to lock in recent gains. U.S. government debt has returned 6.4% since the S&P downgrade and gained 9.8% in 2011, the most since 2008, according to Bank of America Merrill Lynch index data.

Hours after the Moody’s statement, the U.S.’s $32 billion of three-year notes auction drew record demand.

“Serious investors won’t take the Moody’s news with any kind of importance,” Adrian Miller, a fixed-income strategist at GMP Securities LLC in New York, said in a telephone interview. “The concerns of the fiscal cliff and its impact on the credit profile of the country are fully understood. As we get closer to the fiscal cliff, maybe. But there are more important things on our plate.”

The Obama administration’s February budget that was updated in August would result in a debt-to-GDP ratio of 75% in 2022, New York-based Moody’s said. While the S&P rating cut was based in part of the firm’s view of the U.S. political process, Moody’s said it is waiting to see what policies are formulated.

“We will wait and see what they do in 2013, whether or not they come up with a specific proposal,” said Steven Hess, senior vice president at Moody’s in New York. “If there is no result and they delay doing anything serious on deficit reduction, it’s likely that in 2013 we would move the rating down.”

The budget deficit will reach $1.1 trillion this year, according to the CBO. That would be down from last year’s $1.3 trillion, in part because tax revenue has risen by almost 6% and spending is down by about 1% this year.

“Everybody knows that if we don’t get our house in order, we’re in trouble,” said Thomas Roth, senior Treasury trader in New York at Mitsubishi UFJ Securities USA Inc. “If you get downgraded twice, you’re certainly not going to lend to that government at a lower rate.”

The U.S.’s Aaa rating with negative outlook would only be extended beyond 2013 if a “‘fiscal cliff’ actually materialized,” Moody’s said today in the statement. “Moody’s would then need evidence that the economy could rebound from the shock before it would consider returning to a stable outlook.”

House Speaker John Boehner said today that the Democratic-led Senate and a lack of leadership by Obama were to blame for inaction on legislation.

“I’m not confident at all” that lawmakers will find an alternative to the spending cuts to meet the deficit target and avoid the expiration of the tax cut after the Nov. 6 election, the Ohio Republican said in Washington.