Reduction of US credit rating seems inevitable

Wall St dealers estimate a downgrade would cost US Govt $114 billion a year. Photo / Thinkstock

The odds of the US failing to reach a budget deal by August 2 are about 40 per cent, and a reduction of the nation's credit rating "now seems the base case," according to Andrew Laperriere, a managing director at International Strategy & Investment in Washington.

Laperriere said in a note to clients that there are "strong policy and political incentives" for President Barack Obama and House Speaker John Boehner to reach a deal.

That was still possible, but a deal that would alter the trajectory of the ratio of federal debt to gross domestic product now appeared unlikely, he said.

Standard & Poor's placed the US AAA rating on "CreditWatch" on July 14, saying there is a 50 per cent chance it would be cut in the next 90 days even if an agreement is reached by August 2.

Meanwhile, Wall Street bond dealers were yesterday estimating that a downgrade would add US$100 billion ($114 billion) a year to government costs and drag down economic growth.

A US credit-rating cut would likely raise the nation's borrowing costs by increasing Treasury yields by 60 to 70 basis points over the "medium term", said Terry Belton of JPMorgan Chase.

"That impact on Treasury rates is significant," he said.

"That $100 billion a year is money being used for higher interest rates and that's money being taken away from other goods and services."

Treasury Secretary Timothy Geithner says the US will exhaust measures to avoid breaching its US$14.3 trillion debt threshold on August 2.

President Barack Obama has threatened a presidential veto of House Speaker John Boehner's two-step plan slated to be voted on to raise the US debt ceiling and cut US$3 trillion in government spending.

This month ratings agency Moody's put the US on review for downgrade.

Fitch Ratings said it would cut its rating on Treasury securities if the Government's misses a debt payment.

The "short-term" effect on Treasuries of a downgrade would be about 5 to 10 basis points because few asset managers would be forced to sell Treasuries, Belton said.

Boehner offered a two-step plan which would raise the US borrowing limit by up to US$1 trillion and later by US$1.6 trillion while requiring larger spending cuts, according to Republican aides.

"Standard & Poor's has chosen not to comment on the many and varying proposals that have arisen in the current debate,"said John Piecuch, a New York-based spokesman for S&P.

"Any statement to the contrary is inaccurate," he said.

Senate Majority Leader Harry Reid said Boehner's plan "gives the credit agencies no choice but to downgrade US debt" and that the Senate will vote on his proposal soon.

- Bloomberg