By Walter Brandimarte and Daniel Bases
NEW YORK | Wed Aug 3, 2011 5:16am EDT
(Reuters) - The United States had its triple-A rating confirmed by two key ratings agencies on Tuesday after Washington struck a last-minute deal to avoid a debt default, but threats of future downgrades remain.
Moody's Investors Service and Fitch Ratings maintained U.S. ratings for now, but said additional deficit-reduction measures are needed for the government to put its finances in order and retain the coveted rating.
Underscoring that threat, Moody's assigned a negative outlook to the Aaa rating, which means a downgrade is possible in the next 12 to 18 months.
Fitch promised to conclude a more thorough review of the United States by the end of the month and did not rule out slapping a negative outlook on the rating.
Now investors await Standard & Poor's. The agency has been tougher than its rivals, threatening to downgrade U.S. ratings by mid-October if lawmakers did not come up with a plan to meaningfully cut the budget deficit.
The actual plan approved in Washington called for budget savings of $2.1 trillion in the next 10 years, nearly half the amount S&P has said would be enough to support the AAA rating.
"If they stick to what they said, they would downgrade (the United States). But I suspect they are under tremendous pressure not to do so," said Mohamed El-Erian, co-chief investment officer at PIMCO.
On Wednesday, S&P's director of Asian sovereign ratings Takahira Ogawa told Reuters in Singapore that global markets have "to some extent already discounted" the potential risk of a U.S. downgrade. Ogawa, who was not commenting on S&P's U.S. rating, said that most Asian sovereign ratings were on the uptrend.
Also in Singapore, a senior executive of BlackRock Inc, the world's largest money manager with $3.6 trillion in assets, said he sees far less probability of a downgrade of U.S. ratings.
Scott Thiel, BlackRock's deputy chief investment officer for fixed income, fundamental portfolios and head of its European and non-U.S. fixed income group, said the weakening of the U.S. economy is a bigger issue than raising of the debt ceiling.
"Obviously the probability of being downgraded is obviously a lot less now than it was before, having said that it is still not zero," Thiel said.
Lingering anxiety about a possible U.S. downgrade contributed to the poor performance of U.S. stocks on Tuesday, adding to worries about the economy. The S&P 500 turned negative for the year after closing in the red for a seventh day. In Tokyo, the Nikkei average fell more than 2 percent.
ECONOMIC CONCERNS
Both Moody's and Fitch have expressed heightened concern about the performance of the U.S. economy, which is crucial for the efforts of stabilizing the country's debt ratios.
The U.S. economy stumbled badly in the first half of 2011, coming close to contraction in the first quarter. It expanded just 0.4 percent in the first quarter, a sharp downward revision from the previously reported 1.9 percent gain, and rose 1.3 percent in the second quarter.
"The downward revisions of the GDP were bigger than we expected and a source of concern," David Riley, Fitch's top analyst for the United States, told Reuters in an interview.
For Moody's, that economic performance may be just an adjustment period, or may be a sign that the financial crisis permanently damaged the growth potential of the United States.
"We would expect that growth would accelerate in 2012 from the first half of the year," Steven Hess, Moody's top analyst for the United States, said.
"But if it doesn't, that means that the whole process of fiscal consolidation and the plans to achieve lower deficits and lower debt ratios will be made all the more difficult."
Another issue that will be closely monitored by Moody's is the evolution of U.S. borrowing costs in the next few years.
The agency would see it as normal if yields paid on U.S. 10-year Treasury notes rise from the currently "abnormal level" of around 2.6 percent to near 4 percent by 2012 and almost 5 percent by 2016, Hess said, referring to the economic assumptions of the Congressional Budget Office.
DEFICIT REDUCTION
The main difference between Standard & Poor's and its rivals is that S&P has said a meaningful deficit reduction deal, if not agreed now, would be even more difficult in 2012, when presidential elections are likely to increase political divisions in Washington.
Moody's and Fitch seem to be more flexible with that time horizon and willing to give the lawmakers the benefit of the doubt.
The plan just approved in Washington includes initial savings of $917 billion and another $1.5 billion by the end of the year, based on recommendations of a bipartisan joint House and Senate committee. Automatic across-the-board spending cuts would kick in if this mechanism fails.
However, Moody's stressed the new framework is "untested."
"Attempts at fiscal rules in the past have not always stood the test of time," the ratings agency said in a statement. "Therefore, should the new mechanism put in place by the Budget Control Act prove ineffective, this could affect the rating negatively."
(Additional reporting by Raju Gopalakrishnan, Kevin Lim, Saeed Azhar and Harry Suhartono in Singapore; Editing by Richard Borsuk)
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