S&P warns on U.S. debt

The showdown in Washington over the U.S. national debt has prompted Standard & Poor’s to adjust its rating on U.S. Treasuries. While the U.S. still enjoys a AAA rating, S&P warned that there is a one in three chance that it will downgrade the country in the next two years.

“Because the U.S. has, relative to its AAA peers, what we consider to be very large budget deficits and rising government indebtedness, and the path to addressing these is not clear to us, we have revised our outlook on the long-term rating to negative from stable,” the rating agency said in a release.

“We believe there is a material risk that U.S. policy makers might not reach an agreement on how to address medium- and long-term budgetary challenges by 2013. If an agreement is not reached and meaningful implementation does not begin by then, this would in our view render the U.S. fiscal profile meaningfully weaker than that of peer ‘AAA’ sovereigns.”

The announcement sent U.S. stock indices lower by about 2% in the morning, while the price of gold rose $8.50 (0.5%) in London, to $1,493.00.

If the U.S. were downgraded, sovereign borrowing costs would rise, compounding the debt problem. That could ripple throughout the economy, raising consumer borrowing costs and mortgage rates.

“The announcement was seemingly a surprise to the bond market: 30y yields reversed their early morning rally, and the yield curve steepened immediately after the announcement,” wrote Ajay Rajadhyaksha, head of fixed-income strategy at Barclays Capital.

“It was a surprise to us, as well. While we have always emphasized the unsustainable nature of the U.S. deficit and have outlined the likely factors that would drive a lowering of the U.S. AAA rating, we had believed that the rating agencies would wait till after the 2012 elections before taking any action.”

He says the key to regaining a “stable” outlook would be for the government not only to develop a credible plan to reduce the deficit, but to implement it by 2013.

The fight over the deficit and next year’s budget is threatening Washington’s ability to borrow. Analysts say S&P is warning the two parties not to play politics with the debt ceiling.

Treasury Secretary Timothy Geithner said Sunday that Republican leaders have privately assured the Obama administration that Congress will raise the government’s borrowing limit in time to avoid an unprecedented default on the nation’s debt.

But a top Republican quickly pushed back and said there was no guarantee the Republicans would agree to increase the $14.3 trillion debt ceiling without further controls on federal spending.

Geithner has said that the government will hit its current limit no later than May 16. But Geithner said it will be able to avoid an unprecedented default on the national debt through various accounting manoeuvrs for possibly another two months.