Prized AAA rating still under threat

Despite tentative agreement over raising the $US14.3 trillion ($13 trillion) limit, the political stalemate over the past few months may have already caused significant damage. Bond and currency investors yesterday said markets would continue to question Washington's ability to tackle future debt shocks, which has rattled global confidence.

Yesterday's agreement has allowed the US to escape default, although pressure remains on its prized triple-A rating.

"Winston Churchill was right when he said you can count on the Americans to do the right thing when they've tried everything else," said Saul Eslake a director of Grattan Institute, an economic think tank.

"They've staved off the possibility of defaulting in any sense of the term at least until after the next presidential election."

However, it remains to be seen whether the US government's promise to cut spending is going to be enough to satisfy all ratings agencies.

Of the key agencies, Moody's and Fitch are expected to retain triple-A ratings on the US, but Standard & Poor's has warned risks are building.

Last month S&P pointed to a one-in-two chance it could cut the US credit rating.

S&P has said it wants a "credible" plan to reduce the deficit and avoid a downgrade. It suggested that such a plan may need to include a total of about $US4 trillion in budget savings over the next decade and reflect bipartisan support. Yesterday's plan sets out $US2.4 trillion of savings.

S&P will review the agreement and decide what to do this week.

According to Mr Eslake, it is harder to recover a credit rating once it has been cut.

"If the US does lose its rating it will have to perform better than the triple-A standard for while in order to get it back," he said.

In 1986 both Moody's and S&P cut Australia's triple-A rating to the AA-level largely on concerns about spiralling government debt.

It took until 2002 for Moody's to restore Australia's triple-A rating. S&P followed with its own upgrade a year later.

Any downgrade could raise borrowing costs for the US government and also for loans that use the Treasury rate as a benchmark. Fund managers restricted to investing in triple-A rated assets would be forced to dump US Treasuries, causing significant disruption in global markets.

BusinessDay this week reported more than $US12 billion in treasury bonds are held among Australia banks, superannuation funds as well as the Reserve Bank. Any cut to the US credit rating would downgrade the value of these investments.

However, Australia's exposure is relatively modest compared with the biggest holders, including China with $US1.15 trillion, and Japan at $US912.4 billion.

"Because they've seen uncertainty over whether or not the debt ceiling will be raised and the quantum of deficit reductions, this has really undermined the confidence of the markets," said Vivek Prabhu, a credit portfolio manager from Perpetual Investments.

Uncertainty over debt talks has seen a 45 per cent jump in the VIX Volatility Index, an options contract benchmark for the market's expectation of 30-day volatility.

Yesterday's developments are still regarded as a short-term fix. New York-based Blackrock, which ranks as one of the world's biggest bond investors, yesterday urged US authorities to do more to cut back the overall size of debt pile.

"Avoiding default by the US Government is of paramount importance, but investors also need to see a clear path toward deficit reduction that encourages confidence in the US dollar," the fund manager said in a statement.

"This is essential if we are to maintain America's triple-A rating and encourage long-term investment in the US."