US Government Shutdown Means Rating Cut: French Bank
The threat of a US government shutdown is looming as lawmakers continue to negotiate spending cuts. But the country could be in for something worse: losing its prized AAA rating, according to French bank Societe Generale.
"The US deficit is a very real cause for concern," SocGen's Global Head of Research, Patrick Legland, stated in a recent report.
The US national debt surpassed $14 trillion for the first time in history this week. This means that the country is less than $330 billion away from hitting its "debt ceiling" — $14.294 trillion — which is the amount of debt the government is legally allowed to take on.
US Treasury Secretary Timothy Geithner recently warned in a letter that the Treasury Department sees the ceiling being reached between March 31 and May 16 of this year.
Legland also cited China's move away from buying up US Treasurys as another reason to worry.
And with US interest rates remaining at record lows, major foreign investors such as China, Japan and Europe are reconsidering the purchase of large amounts of government debt, SocGen said.
"Foreigners currently hold 47 percent of US debt, or around $4,200 billion," the research note said.
A repatriation of Japanese capital and the resolution of Europe's sovereign debt problems could be key factors in pushing Treasury yields higher and shifting concerns to the US, especially as the Federal Reserve ends its $600 billion bond-buying program.
"The outlandish scenario of a US debt downgrade is no longer the stuff of finance fiction," Legland warned in his note, adding that it could take place far quicker than many would like to think.
A big indicator for a debt downgrade by ratings agencies is the net interest/government revenue ratio, Societe Generale reported in its note.
The threshold triggering a downgrade from AAA is around 10 percent of general government finances (local governments included), according to Legland, who says that the US net interest/government revenue ratio stands at around 18 percent.
"Breaching the 18 percent threshold would almost certainly trigger a downgrade," the bank's research states. "But warnings would likely come much sooner, at around 14 percent."
But with sustainable, albeit slow, economic growth and rising inflation, the threat of a rate hike has arisen.
Should interest rates rise, and Obama's tax reforms are enacted, the US stands a chance in moving out of the 14-18 percent region (also known as the debt reversibility band), SocGen noted, adding that a 200 basis point rise within the next two years would clearly put the US in AA territory.
But there is an upshot, the bank notes: the US does have the advantage of being a reserve currency to which many other countries are pegged. This acts as a mitigating factor as central banks have no choice but to continue buying US assets.