Fitch Ratings has placed the United States’ ‘AAA’ Long-Term Foreign-Currency Issuer Default Rating (IDR) on Rating Watch Negative. Markets have grown increasingly concerned about the deadlock, with growing premiums on Treasury bills maturing when the danger of default is greatest, and the S&P 500 Index falling for two days. Economists predict that a US default would result in widespread job losses and an increase in borrowing rates.
In a statement released on May 24, Fitch explains its rating action.
The Rating Watch Negative reflects increased political partisanship that is hindering reaching a resolution to raise or suspend the debt limit despite the fast-approaching x date (when the U.S. Treasury exhausts its cash position and capacity for extraordinary measures without incurring new debt).
Fitch still expects a resolution to the debt limit before the x-date. However, we believe risks have risen that the debt limit will not be raised or suspended before the x-date and consequently that the government could begin to miss payments on some of its obligations.
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The brinkmanship over the debt ceiling, failure of the U.S. authorities to meaningfully tackle medium-term fiscal challenges that will lead to rising budget deficits and a growing debt burden signal downside risks to U.S. creditworthiness.
The U.S. reached its $31.4 trillion debt limit on Jan. 19, 2023, and the Treasury began taking extraordinary measures in order to avoid breaching the ceiling. The Treasury has stated that these extraordinary measures could be exhausted as early as June 1, 2023.
The cash balance of the Treasury reached USD76.5 billion as of May 23 and sizeable payments are due June 1-2, meaning that the x-date could arrive as the Treasury indicated and before an agreement is reached or finalized with votes in the House and Senate.
The failure to reach a deal to raise or suspend the debt limit by the x-date would be a negative signal of the broader governance and willingness of the U.S. to honor its obligations in a timely fashion, which would be unlikely to be consistent with a ‘AAA’ rating, in Fitch’s view.
Prioritization of debt securities over other due payments after the x-date would avoid a default. Similarly, avoiding default by non-conventional means such as minting a trillion-dollar coin or invoking the 14th amendment is unlikely to be consistent with a ‘AAA’ rating and could also be subject to legal challenges.
We believe that failing to make full and timely payments on debt securities is less likely than reaching the x-date and is a very low probability event. Such a failure would be a debt default under Fitch’s sovereign rating criteria and would lead us to downgrade the sovereign IDR to Restricted Default (RD).
Affected debt securities would be downgraded to ‘D’. Additionally, other LT debt securities with payments due within the following 30 days would likely be downgraded to ‘CCC’, and ST treasury bills maturing within the following 30 days would likely be downgraded to ‘C’.
Other debt securities with payments due beyond 30 days would likely be downgraded to the expected post-default rating of the IDR. A key consideration in determining the U.S. post-default rating would be Fitch’s Sovereign Rating Model (SRM) – the details of which are in the public domain. The SRM output for the U.S. stands at ‘AA+’. The model applies a two-notch reduction for a sovereign that has recently defaulted, suggesting that Fitch’s model-implied post-default rating would be ‘AA-‘.
The final rating could be adjusted lower or higher via the Qualitative Overlay as per our criteria. Fitch would expect any debt default to be relatively short-lived. However, a more protracted default scenario could have more severe implications for the country’s post-default ratings.
Fitch would expect the U.S country ceiling to remain at ‘AAA’ even in the scenario of a debt default. The U.S. dollar is the preeminent world’s reserve currency, and we view the risk of exchange and capital controls as de minimis.
