THE US is by no means out of the woods even after an 11th-hour deal that allows Washington to again borrow from global markets to help pay its mounting interest bill.
Despite tentative agreement over raising the $US14.3 trillion ($A12.9 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.
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 will be enough to satisfy all the ratings agencies. Among the key agencies, Moody's and Fitch are expected to retain their triple-A ratings on the US, but Standard & Poor's has warned that risks of a cut are building. Last month S&P pointed to a one-in-two chance it could cut the country's prized triple-A credit rating.
S&P has said it wants a "credible" plan to reduce the deficit, in order to avoid a downgrade. The agency has suggested that such a plan may need to include about $US4 trillion in budget savings over the next decade and reflect bipartisan support. Yesterday's plan sets out $US2.4 trillion of savings over the decade. The focus will be on S&P this week as it decides what to do.
According to Mr Eslake, it is hard 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 a 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. Both agencies issued a further cut in 1989, although the ratings remained in the AA-band.
It was not until 2002 that Moody's restored Australia to a triple-A rating. S&P followed with an upgrade to triple-A a year later.
Any downgrade could raise borrowing costs not only for the US government but for loans that use the Treasury rate as a benchmark. Some fund managers that are restricted to investing only in triple-A rated assets would be forced to dump US Treasury bonds, a move that would cause significant disruption in global markets.
BusinessDay this week reported that more than $US12 billion in Treasury bonds are held by Australian banks, superannuation funds and the Reserve Bank. Any cut to the US credit rating would force the holders to take a haircut on 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.
"Markets don't like uncertainty and 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 caused a 45 per cent jump in the VIX Volatility Index in the past week. This options contract is a globally recognised benchmark for the market's expectation of 30-day volatility.
Frequently Asked Questions about this Article…
What was the recent US debt ceiling deal and why does it matter to investors?
A last‑minute agreement raised the US debt limit to about US$14.3 trillion, allowing Washington to keep borrowing and avoid immediate default. For investors this matters because the political fight and the size of the compromise have shaken confidence in the US government's ability to manage future debt shocks and could affect bond, currency and equity markets.
Is the US at risk of losing its triple‑A credit rating?
Yes. Although Moody's and Fitch are expected to keep their triple‑A ratings for now, Standard & Poor's has warned a downgrade is possible — it recently said there was roughly a one‑in‑two chance of a cut. S&P wants a more 'credible' deficit reduction plan before ruling out a downgrade.
What kind of deficit reduction does S&P want and how does the current plan compare?
S&P has suggested a credible plan may need around US$4 trillion in budget savings over the next decade. The recent agreement outlines about US$2.4 trillion of savings over that period, which leaves a gap S&P will weigh when it decides whether to downgrade.
How would a US credit‑rating downgrade affect borrowing costs and markets?
A downgrade could raise borrowing costs for the US government and for loans benchmarked to Treasury rates. It could force funds restricted to triple‑A assets to sell US Treasuries, causing market disruption, and generally increase volatility and uncertainty in global markets.
How exposed are Australian investors and institutions to US Treasury holdings?
Australian banks, superannuation funds and the Reserve Bank hold more than US$12 billion in US Treasury bonds. While meaningful, that exposure is relatively modest compared with the largest holders such as China and Japan.
Who are the biggest holders of US Treasuries and why does that matter?
The article notes China holds about US$1.15 trillion and Japan about US$912.4 billion in Treasuries. Large holders matter because any downgrade or forced selling by investors restricted to AAA assets could lead to sizable market moves and valuation impacts for major global holders.
Has uncertainty over the debt talks already affected market volatility?
Yes. Uncertainty around the debt ceiling and the size of deficit reductions has driven the VIX volatility index up about 45% in the past week, reflecting increased expectations of near‑term market volatility.
What should everyday investors watch next regarding the US credit rating?
Investors should watch Standard & Poor's upcoming decision and whether Washington produces the kind of bipartisan, credible deficit‑reduction plan S&P has signaled it wants. Ratings action from S&P could influence borrowing costs, market confidence and the value of Treasury holdings.
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