Moody’s Investor Service, the credit rating agency, will fire a warning shot at the US on Monday, saying that unless the country gets public finances into better shape than the Obama administration projects there would be “downward pressure” on its triple A credit rating...

Originally posted by airforce:
Moody's Investor Services, one of the top bond rating agencies, has some tough words for the United States .

Quote

Moody’s Investor Service, the credit rating agency, will fire a warning shot at the US on Monday, saying that unless the country gets public finances into better shape than the Obama administration projects there would be “downward pressure” on its triple A credit rating...

It really was only a matter of time.

Onward and upward,
airforce

March 15 (Bloomberg) -- The U.S. and the U.K. have moved “substantially” closer to losing their AAA credit ratings as the cost of servicing their debt rose, according to Moody’s Investors Service.

The governments of the two economies must balance bringing down their debt burdens without damaging growth by removing fiscal stimulus too quickly, Pierre Cailleteau, managing director of sovereign risk at Moody’s in London, said in a telephone interview.

Under the ratings company’s so-called baseline scenario, the U.S. will spend more on debt service as a percentage of revenue this year than any other top-rated country except the U.K., and will be the biggest spender from 2011 to 2013, Moody’s said today in a report.

“We expect the situation to further deteriorate in terms of the key ratings metrics before they start stabilizing,” Cailleteau said. “This story is not going to stop at the end of the year. There is inertia in the deterioration of credit metrics.”

The pound fell against the dollar and the euro for the first time in three days, depreciating 0.8 percent to $1.5090, while the dollar index snapped a four-day drop, adding 0.3 percent to 90.075.

The U.S. government will spend about 7 percent of its revenue servicing debt in 2010 and almost 11 percent in 2013, according to the baseline scenario of moderate economic recovery, fiscal adjustments in line with government plans and a gradual increase in interest rates, Moody’s said.

Under its adverse scenario, which assumes 0.5 percent lower growth each year, less fiscal adjustment and a stronger interest-rate shock, the U.S. will be paying about 15 percent of revenue in interest payments, more than the 14 percent limit that would lead to a downgrade to AA, Moody’s said.

U.K. Debt Service

The U.K. is likely to spend 7 percent of revenue servicing debt this year and 9 percent in 2013, rising to almost 12 percent under the adverse scenario, Moody’s said.

Financing costs above 10 percent put countries outside of the AAA category into a so-called debt reversibility band, the size of which depends on the ability and willingness of nations to reduce their debt burden by raising taxes or reducing spending. The U.S. has a 4 percentage-point band, while the U.K. has a 3 percentage-point band.

“Those economies have been caught in a crisis while they are highly leveraged,” Cailleteau said, referring to the level of private and public debt as a percentage of gross domestic product. “They have to make the required adjustment to stabilize markets without choking off growth.”

The U.S. would be the “most affected” under the adverse scenario, as the only country that would face a downgrade, Cailleteau said. The company’s baseline scenario assumes that all current AAA sovereigns will keep their ratings over the next three years, he said.

‘Warning Shot’

“On balance, we believe that the ratings of all large Aaa governments remain well positioned, although their ‘distance-to- downgrade’ has in all cases substantially diminished,” Moody’s said in the report.

None of the current Aaa rated countries are likely to lose their ratings, said Peter Chatwell, a fixed-income strategist at Credit Agricole CIB in London.

“This report is a warning shot to governments, setting out the line that they can’t cross with their budgets,” he said.

While the U.S. is likely to benefit from economic growth more than other AAA nations, weak public consumption is likely to weigh on GDP this year, the ratings company said.

“The pattern of growth and the high rate of unemployment raise the question of how strong the recovery will be going forward,” Moody’s said. “The ability of the U.S. economy to grow more rapidly and, therefore, for government revenues to contribute to fiscal consolidation, will have to depend on a revival in the growth of consumption.”

U.S. Growth

The U.S. economy will grow 3 percent this year and in 2011 after contracting 2.4 percent in 2009, according to the median estimate of economist forecasts compiled by Bloomberg. Unemployment will average 9.6 percent this year, up from 5.8 percent in 2008, and will fall to 9 percent next year, based on the median estimate.

Sales at U.S. retailers unexpectedly climbed 0.3 percent in February, compared with a median forecast for a 0.2 percent contraction, the Commerce Department said on March 12.

“The emphasis of the market, and our own, will move increasingly away from public finance developments in 2010, towards medium-term consolidation plans and the credibility thereof,” Moody’s said.

Achieving the fiscal consolidation necessary to avert a downgrade will test “social cohesion” and may involve rewriting the “social contract” between governments and their people, Cailleteau said. “People have to decide what level of pain they are willing to accept to have a healthy economy.”

U.K. Prime Minister Gordon Brown has clashed with opposition leader David Cameron over the timing and speed of budget cuts as they prepare for an election that must be held by June 3.

‘Very Fragile’

The opposition Conservatives argue that the government should come to grips now with the budget deficit, while Brown’s Labour Party says it’s too soon to remove fiscal stimulus.

“Although the economy is now growing, recovery is still in its early stages and remains very fragile,” Brown told business leaders in London on March 10. “We’re not going to withdraw the stimulus until the recovery is assured.”

The U.K. economy, which emerged from its longest-ever recession last quarter, is forecast to expand by 1.2 percent this year after a 5 percent contraction in 2009, according to median economist estimates compiled by Bloomberg. Unemployment will average 8 percent this year and 7.9 percent next year, the estimates show.

“The question here is less when fiscal retrenchment ought to start, but rather how credible it is that sufficient retrenchment will take place,” Moody’s said.

The US rating agency said the US, the UK, Germany, France, and Spain are walking a tightrope as they try to bring public finances under control without nipping recovery in the bud. It warned of "substantial execution risk" in withdrawal of stimulus.

"Growth alone will not resolve an increasingly complicated debt equation. Preserving debt affordability at levels consistent with AAA ratings will invariably require fiscal adjustments of a magnitude that, in some cases, will test social cohesion," said Pierre Cailleteau, the chief author.

"We are not talking about revolution, but the severity of the crisis will force governments to make painful choices that expose weaknesses in society," he said.

If countries tighten too soon, they risk stifling recovery and making maters worse by eroding tax revenues: yet waiting too is "no less risky" as it would test market patience. "At the current elevated debt levels, a rise in the government's cost of funding can very quickly render debt much less affordable."

Moody's said Britain has been slower than Spain to "rise to the challenge" and may be at greater risk of smashing through buffers of AAA creditiblity if rates suddenly rise. Spain made errors at the outset of the crisis but has since become a model pupil, pledging to cut the budget deficit from 11.4pc of GDP to 3pc by 2013.

Britain is moving much more slowly, cutting its deficit to around 5.5pc of GDP over four years – though written into law, unlike Spain's pledge. At best, debt is likely to stabilise at 90pc of GDP. It could reach 100pc by 2013 if growth falters.

The Treasury said the assessment is unduly gloomy given that the maturity of UK debt is over 14 years, double the AAA average. This greatly reduces roll-over risk, giving Britain time to steady the ship.

The concern is what will happen as the Bank of England stops purchasing bonds. An IMF study said quantitative easing had lopped 40 to 100 basis points off debt costs. "The discontinuation of these purchases creates upside risk to yields," said Moody's.

Moody's said the saving grace for both Britain and the UK is a good a track record of belt-tightening when necessary, and a tax and spending structure that makes it easier to whittle away the debt once recovery starts. Concerns about a hung Parliament in Britain appear overblown given the broad political consensus on the need for austerity.