U.S. bond prices have fallen, along with the dollar and the S&P 500 Index, following Standard & Poor's decision on Monday to slap a "negative" outlook on America's AAA credit rating because it believes the U.S. doesn't have a plan to rein in its rising budget deficits and debt.
In its report, the credit rating agency cited 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 other top-rated AAA countries. According to S&P, there's a one-in-three chance that it will need to downgrade America's credit rating within two years.
The Treasury Department, in turn, argued that, contrary to S&P's assessment, the White House and Congress can come together to rein in mounting deficits. "We believe S&P's negative outlook underestimates the ability of America's leaders to come together to address the difficult fiscal challenged facing the nation," said Treasury spokesperson Mary Miller.
The S&P 500 declined 1.5 percent to 1,300.24 shortly before 10 a.m. in its biggest drop since mid-March, according to Bloomberg. The yield on the 10-year Treasury note rose three basis points to 3.44 percent after falling four basis points earlier.
As Bloomberg points out, President Obama's 2012 budget estimates the U.S. debt ceiling will be $20.8 trillion in 2016, while the budget proposed by Republican Budget Committee Chairman Paul Ryan requires a debt ceiling of $19.5 trillion. The Treasury Department has projected that the government could reach its current $14.3 trillion debt ceiling in May and be forced to default by July if the debt ceiling isn't raised.
So, is S&P's warning a big deal? Here's how analysts are parsing the news:
The Bank of Ireland's Paul Harris tells Reuters that while S&P's judgment isn't unexpected, it refocuses the market on America's economic problems rather than the threats posed by the Middle East uprisings. Investment advisor Hugh Johnson calls S&P's move a "big surprise" and thinks the announcement will put pressure on Democrats and Republicans to "move faster at reducing the deficits, or cutting spending and possibly increasing taxes," which might prove dangerous as the economy recovers from recession.
NOT BIG DEAL
S&P is correct in worrying about "political gridlock" in the U.S., Paul Krugman says at The New York Times, since the U.S. "is perfectly capable both of running large deficits now and getting its fiscal house in order over time; but not if the parties cannot agree on any kind of solution." Yet he adds that S&P downgraded Japan in 2002 and the country didn't suffer much harm. "So, no big deal," Krugman concludes. Kevin Giddis at Morgan Keegan, meanwhile, doesn't think the U.S. will default on its debt. "The U.S. will continue to do what it takes to make sure there is enough money, enough debt, and enough liquidity to ensure economic growth, while over time, reducing the deficit," he tells CNN.
MAYBE A BIG DEAL
The U.S. is truly in worse fiscal shape than its AAA peers and a downgrade could prove a "huge shock to the financial system," writes Felix Salmon at Reuters, but the U.S. "losing its triple-A now, post-crisis, would not be nearly as harmful as if it had lost its triple-A before the crisis" because the credit rating agencies "have lost most of their credibility." What's more, he adds, S&P probably won't act on its threat to downgrade America's credit rating because doing so could threaten the agency's very rating system. If U.S. Treasury bonds, which are backed by the government, "aren't risk-free," Salmon reasons, "then nothing is risk-free."