The chances of a credit downgrade from a major ratings agency in the wake of the debt ceiling standoff between House Republicans and the Biden Administration are higher than they have been in over a decade. But why is this time any different?
For decades, US Treasury securities have been considered a safe haven for investors, providing stability to retirement plans, corporate balance sheets, and investment accounts. However, the looming debt-ceiling standoff has raised concerns about a potential credit downgrade, reminiscent of the 2011 episode when the United States’ credit rating was downgraded by Standard & Poor’s (S&P).
The 2011 debt standoff and subsequent credit downgrade
During the 2011 debt-ceiling showdown, the US government came perilously close to defaulting on its obligations. S&P responded by downgrading the US credit rating by one notch. While other rating agencies did not lower their AAA ratings, Moody’s and Fitch changed their outlook for US debt to negative, indicating a higher likelihood of a downgrade if trends persisted.
The current fiscal situation in 2023 is objectively worse than it was in 2011. The national debt has more than doubled, reaching over $31 trillion, and the total federal debt as a percentage of GDP has risen from 65% to 95%. The Congressional Budget Office projects it to reach 132% in the next decade, coinciding with potential funding challenges for Medicare and Social Security.
One of the factors contributing to the US fiscal strain is the increase in interest payments on the mounting debt. With the Federal Reserve’s recent unprecedented rate hikes caused by rapidly rising inflation as a result of the influx of liquidity that was necessary for the COVID-19 relief programs, US borrowing costs have surged. In 2011, interest payments on all US debt totaled $425 billion, rising to $710 billion in 2022. The first quarter of 2023 witnessed interest payments reaching a staggering $929 billion on an annualized basis, equating to the nation’s defense budget.
As the US faces another debt-ceiling standoff, analysts warn of the possibility of further credit downgrades. S&P, in particular, has highlighted that a failure to raise the debt ceiling and any form of default could negatively impact the strength of American institutions, potentially leading to a downgrade.
The current fiscal standoff
While Moody’s and Fitch have maintained their AAA ratings for now, Fitch expressed concern over the entire debt-ceiling process, stating that it no longer serves a purpose in guiding fiscal decisions. The agency criticized the repeated near-default episodes resulting from debt-limit debates, emphasizing that such political dysfunction could erode confidence in the US government’s repayment capacity, affecting the sovereign credit profile.
As the fiscal standoff continues, analysts speculate that the debt-ceiling impasse could potentially result in Fitch placing the US rating on negative watch and taking further rating action if default becomes a significant risk.
Biden expresses confidence in reaching debt deal amid G-7 summit
President Joe Biden, currently attending the G-7 summit in Japan, remains optimistic about reaching a deal with House Republicans to avoid a potential default on the nation’s debt. When asked about the status of the negotiations, Biden expressed confidence, citing his experience in similar negotiations throughout his political career. He emphasized that talks progress in stages and appeared relaxed, stating that he believes a default can be avoided and that a favorable outcome can be achieved.
While meeting with Australian Prime Minister Anthony Albanese, Biden apologized for canceling his planned trip to Sydney in order to address the budget impasse and the looming debt ceiling issue. Albanese, understanding the circumstances, expressed his support, highlighting the temporary nature of political decisions and reaffirming the enduring friendship between the two countries.
Although the president exuded calmness regarding the negotiations, some of his aides, including White House communications director Ben LaBolt, delivered more forceful statements. LaBolt criticized Republicans for their proposed budget cuts, deeming them extreme. However, he also suggested that there is still a possibility for a reasonable bipartisan agreement if Republicans return to the negotiating table in good faith.
Biden’s decision to cancel diplomatic engagements in the Indo-Pacific region has raised concerns among some, as it could potentially allow China to portray the United States as an unreliable partner to other nations in the region.
At the G-7 summit, Biden and Albanese signed a statement of intent to strengthen joint efforts in combating climate change and expressed enthusiasm for enhanced cooperation in defense matters. Jake Sullivan, Biden’s national security adviser, acknowledged the interest of other G-7 leaders in the Washington negotiations. Sullivan reassured that while the situation is a significant topic of discussion, it has not caused alarm among the attending countries. The president has conveyed his belief that a positive outcome can be achieved.
As negotiations continue, the eyes of the international community remain fixed on the United States, eagerly awaiting the resolution of the debt ceiling standoff.
It remains to be seen how the debt-ceiling showdown will unfold and whether it will prompt lawmakers to reevaluate the effectiveness and necessity of this process in the future. Nonetheless, the implications of a credit downgrade in the wake of a US government default would have far-reaching consequences for the world’s largest bond market and the stability of global financial markets.
