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'Band Aid’ Deal May Pressure S&P to Slash US Rating

Sunday night's deal that will see the US debt ceiling raised if it passes a vote in the House is merely a "band aid" and certainly not a game changer, according to an assessment from Barclays Capital.

AP

The deal “is certainly not a game-changing breakthrough, and will keep the possibility of a near-term rating downgrade alive; it represents, in our view, just a band-aid approach on the way to more sustainable public finances,” said Julian Callow, the chief European economist at Barclays Capital in a research note on Monday.

The big problem for Callow is the slowdown in the US economy, which could mean any savings are offset by significantly lower revenue.

“All of the putative fiscal savings could effectively be wiped out if US GDP outturns continue to be significantly weaker than is assumed in government fiscal baseline projections,” Callow said.

Unless the credit ratings agencies believe the new enforcement mechanism is credible, Callow predicts they will downgrade US debt even though the debt ceiling has been raised.

“Given that the prospective cuts under the deal lie still well below the $4 trillion figure which S&P had commented would be a "good down-payment," then this issue is unlikely to recede substantially,” said Callow

Like Callow, Danske Bank chief analyst Allan von Mehren believes a downgrade of US debt is now in the cards.

“Lower growth will also weigh on the budget and — all else equal — requires even higher discretionary budget cuts to reduce the deficit and get debt under control,” said Mehren in a research note.

“It is not an easy decision to downgrade sovereign debt of the world’s leading reserve currency and it will require some courage to do this.”

“We believe, though, that S&P’s credibility is at stake here — and given the signals it has sent we believe it will prove hard not to follow through and downgrade US debt,” Mehren said.

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