Full Fitch Statement Shows US Downgrade Risk Remains In Play

By Win Thin

Here is some more color on the Fitch comments on the US. First headline to hit the tapes was that the “deal reached is commensurate with AAA rating.” However, the full statement is that “commensurate with its ‘AAA’ rating, the risk of sovereign default remains extremely low.” Fitch added that it is an important step in the right direction, but not the end of the process in terms of credible debt reduction. Fitch said it will conclude its US review by the end of August, and noted that “The fundamental economic and financial underpinning of the United States’ ‘AAA’ status remains strong despite the heated political debate.” Also, that “the interest burden of federal debt is projected to remain moderate by historical standards and broadly in line with ‘AAA’ peers.” However, Fitch said that it “projects that US government debt, including debt incurred by state and local governments as well as the federal government, will reach 100% of GDP by the end of 2012, and will continue to rise over the medium term – a profile that is not consistent with the United States retaining its ‘AAA’ sovereign rating.”

So Fitch’s overall stance is quite balanced, and has by no means removed downgrade risks for the US. And we have yet to hear from the other two, S&P and Moody’s. Head of S&P last week walked back the $4 trln in cuts attributed to S&P as what’s needed to avoid a downgrade, and so the softer stance means that the S&P rating outlook remains cloudy. Our sovereign rating model just barely still rates the US as AAA/Aaa/AAA, but we admit that hinges in part on the dollar’s status as a reserve currency. Taking that away leads to a lower rating of AA+/Aa1/AA+. Rating agency behavior is getting harder and harder to predict as the crisis wears on, and we think the markets at this point are resigned to a US downgrade by at least one of the agencies. And yet US 5-years CDS is trading around 54 bp, which is near Sweden (51 bp) and lower than Australia (57 bp), the Netherlands (61 bp), Germany (65 bp), and Canada (65 bp), all truly AAA countries. Outside of the US, we continue to see downgrade risk ahead in France, UK, Belgium, and Japan. Within the euro zone periphery, Spain, Italy, Ireland, and Portugal all face significant downgrade risk still, while Greece appears correctly rated for now.