The case against the US triple-A rating

By:
Jeremy Weltman
Published on:

US indicators are slowly improving, but Euromoney’s country-risk experts are still not as confident in its creditworthiness compared with the rating agencies. The question is why?

The US is a prime triple-A investment, according to Fitch and Moody’s. However, with S&P a dissenter – awarding a lower AA+ rating for the past three years on a stable outlook – and Euromoney’s survey suggesting its risks are a touch higher, US bond safety is far from guaranteed.

Euromoney’s country-risk score of 75.6 out of a possible 100 points – where a higher score is safer and a lower one more risky – places the US 16th on its global rankings table, comprising 189 sovereign issuers worldwide.

That puts it within the second of ECR’s five tiered categories, equivalent to an A- to AA credit rating, lower than any of the credit ratings it is assigned.

 

Euromoney’s survey has a solid track record in gauging creditworthiness, predicting ratings actions and identifying value in CDS spreads. Its contributors are asked to quantify 15 economic, political and structural risk indicators, which are then added to scores for access to capital, credit ratings and debt indicators to provide the total risk score.

The US score has remained fairly steady for the past couple of years after falling sharply in the wake of the failure of Lehman Brothers in 2008, with some interim volatility in the wake of last year’s government shutdown.

The score is now improving, but slowly, rising by less than one point this year – and one place in the rankings – suggesting there are still some doubts among Euromoney’s 51-strong panel of US economists and other country-risk experts.

More than one risk factor to weigh up

A comparison of the US with tier-one, triple-A rated Canada, ranking ninth, helps to shed some light on its perceived weaker fundamentals.

Canada receives higher scores for all five of its economic risk sub-factors: bank stability, the economic-GNP outlook, monetary policy/currency stability, employment/unemployment and government finances. The latter shows the largest gap (see chart), with Canada scoring 7.4 out of 10, but the US a mere 5.1 – a differential that can be easily explained in light of their contrasting fiscal trends.

 

Canada’s net lending position (its fiscal deficit) is narrowing from a peak of 4.9% of GDP in 2010 to 2.5% this year, according to the IMF’s current World Economic Outlook. The structural deficit will come in below 2% of GDP, and gross debt, having peaked last year at 89.1% of GDP, will ease to 87.4%.

The US deficit is around 6.6% of GDP, despite narrowing since 2009 when it ballooned to 14.7% in the wake of the financial meltdown. The US structural deficit will be 5% of GDP this year, with gross debt exceeding 105% of GDP and a net debt burden of 82% – double that predicted for Canada.

The US Bipartisan Budget Act and the raising of the debt ceiling were, in the IMF’s words, "important steps to reduce fiscal risks". However, as the IMF also warns: "The need for a medium-term fiscal adjustment to ensure a downward path for the public debt remains."

As an issuer of the world’s reserve currency, US creditworthiness is a relative term, and many of its political risk factors, including capital repatriation, corruption, transparency and institutions, are of no particular concern, all scoring admirably – if a touch lower than Canada.

New York-based Lance Widner, senior director and portfolio strategist at Oppenheimer Asset Management, states: "An AA-equivalent rating is still not bad in the aftermath of the global financial crisis, and is still a long way from suggesting the US isn’t going to make good on its debt repayments."

US fiscal indicators are nevertheless worse than those for the eurozone as a whole, and as previous lockdowns arising from the composition of Congress and the Senate highlight, there are still risks from the regulatory and policymaking environment, and government instability.

Widner is leaning towards a higher score (and rating) with the economy improving and a quantitative-easing exit strategy following, but is not quite convinced, arguing: "The rating agencies have not always been right during large-scale downturns."

Washington DC-based IMF senior economist Andreas Jobst believes the US risk profile is suffering from a range of problems, including its fiscal indicators, negative surprises in the Q1 GDP report, and uncertainty with respect to monetary policy, with "the US Fed in particular having a hard time communicating its strategy to the markets", he says.

There are also several structural risks lurking in the background, including population ageing and productivity growth to factor in. 

Incredibly, some 50 million Americans are defined as living in poverty, putting pressure on healthcare and other entitlement spending, which is projected to rise from 9.8% of GDP in 2013 to more than 14% by 2039, suggests CBO’s Long-Term Budget Outlook. 

Worst-case scenarios show the public debt rising to 190% of GDP by 2038, putting pressure on future governments to act.

This article was originally published by ECR. To find out more, register for a free trial at  Euromoney Country Risk.