DBRS Confirms United States of America at AAA

DBRS, Inc. (DBRS) confirmed the United States of America’s Long-Term Foreign and Local Currency – Issuer Ratings at AAA. DBRS confirmed the Short-Term Foreign and Local Currency – Issuer Ratings at R-1 (high). The trend on all ratings is Stable.

KEY RATING CONSIDERATIONS

The Stable trend reflects DBRS’s view that the strength of the U.S. economy, institutions and financial markets will continue to provide support to the rating. Economic growth has been strong but is slowing toward potential as labor market constraints and less accommodative policies begin to take effect. Although risks to growth appear skewed to the downside, the Federal Reserve has policy space to manage an unexpected downturn, and private sector balance sheets are generally in good condition. The federal fiscal deficit has nonetheless widened, creating two problems, one short-term and one medium-term. In the short-term, it increases the frequency with which Congress must act to raise the debt ceiling, with individual political parties often linking the debt ceiling to other policy debates and increasing the risk of nonpayment if a compromise is not reached in a timely manner. In the medium-term, the deficit leaves the U.S. poorly equipped to manage the fiscal pressures associated with an aging population.

RATING DRIVERS

Near-term pressure on the U.S. rating appears unlikely. However, a failure to reduce projected fiscal deficits over the medium-term could limit fiscal flexibility in future downturns and ultimately jeopardize the federal government’s AAA rating. Diminished bipartisanship within Congress and the use of the debt ceiling as a means of pressuring political opponents could also raise questions about the willingness of the U.S. government to pay its obligations on time and in full.

RATING RATIONALE

U.S. Growth is Slowing Due to Capacity Constraints but Macroeconomic and Financial Fundamentals Remain Strong.

The U.S. economy is entering its 10th year of uninterrupted expansion. Labor market slack has largely dissipated. Growth has been relatively strong during 2017-18 (0.7% per quarter on average), as the 2017 tax cut provided some additional stimulus, labor force participation saw a modest increase, and the output gap continued to shrink. DBRS expects growth to moderate in 2019-2020, as capacity constraints begin to bind, the effects of the tax cut wane, and financial conditions become less supportive. The ability of the U.S. economy to grow at a stronger pace will depend on productivity gains from investment, including into infrastructure.

Gradually rising interest rates and a shrinking Federal Reserve balance sheet have kept inflation in check while contributing to slower growth. Recent signals of a potentially extended pause in interest rate hikes seem appropriate, given some softness in economic data during Q4 2018 and Q1 2019. The housing market, and particularly housing in high cost areas, seems to have softened in response to rising interest rates and changes in the tax deductibility of state and local taxes. However, the economy has shown resilience and household net worth has risen steadily (excluding the temporary drop in Q4 2018 due to the stock market correction). Consumer credit continues to grow at rates slightly in excess of nominal GDP, suggesting that the strong employment outlook combined with steady wage growth is boosting household confidence.

At this juncture, the threat of rising interest rates has eased somewhat with the shift in the Federal Reserve’s stance. DBRS remains concerned over pockets of leverage in the household and corporate sectors, but this appears unlikely to materially dampen the overall macroeconomic outlook. Investment could be adversely affected by a rise in tariffs and the likely retaliation by other countries. Some younger households could wind up in a difficult position as housing and educational affordability declines. In spite of these risks to the economic outlook, Fed policy is likely to respond effectively to any sharp swings in unemployment and inflation. DBRS considers U.S. economic fundamentals to be strong.

External Accounts are Resilient but Gradually Deteriorating Due to a Strong Dollar and Growth Differentials

The U.S. current account deficit, which has averaged 2.5% since 2009, widened slightly in Q4 2018 to 2.6% of GDP. In US$ terms, the current account has weakened since 2016, driven by a shift in the goods trade deficit from $751 billion in 2016 to $891 billion in 2018. A relatively strong dollar combined with slowing growth in Europe and Japan (from mid-2017) appear to have contributed to the wider deficit. Uncertainty on trade policy and the imposition of tariffs on China have not helped to reduce the deficit; instead, imports have risen, reflecting both the weaker currencies of some key trading partners and the incentive to boost imports ahead of any impending tariff hikes. Nonetheless, capital flows into and out of the United States remain highly diverse and resilient. Net primary income remains positive, suggesting that the U.S. financial system retains key advantages in allocating risk capital globally. The pace of global reserve accumulation has remained relatively subdued since 2014, but the role of the dollar and the U.S. Treasury market as reserve assets is unlikely to change dramatically.

Fiscal Imbalances, If Unaddressed, Could Weaken U.S. Credit Fundamentals Over the Medium Term.

The federal deficit deteriorated to 3.9% of GDP in 2018 and is expected to reach over 5% of GDP in 2019. Primary dealers expect net borrowing by the Treasury to reach $1.23 trillion (5.2% of GDP) by 2021, suggesting that official budget projections may prove overly optimistic. Gross federal receipts have been broadly stable in nominal terms, with rising employment and wages supporting an increase in personal income tax receipts that has more than compensated for the loss in corporate tax revenue associated with the 2017 Tax Cuts and Jobs Act. Overall spending has increased markedly, particularly on defense, interest, and social security (together representing 60% of federal outlays). Measured on a 12-month basis, defense spending has increased by $99 billion (16.8%) since CY2016. Social security outlays grew by over $118 billion during the same period, reaching $1.0 trillion as of Q1 2019. Interest payments have increased by $99 billion over the same period, reflecting the normalization of Federal Reserve policy interest rates.

In this context, long-term fiscal pressures remain a concern and the U.S. lacks a credible medium-term plan to reduce the deficit. Due primarily to rising entitlement spending and interest costs, outlays are expected to rise from 20.6% of GDP in 2018 to 23.6% of GDP by 2028. The cost of social security is expected to fall below the program’s income for the first time in 2019. In addition, under current law, several key tax cuts enacted in the TCJA are programmed to expire in 2026, but may ultimately be extended by Congress in the future. There is a general lack of bipartisan agreement on how to address the long-term imbalance in social security, on an overall approach to health care reform, and on how to ensure U.S. tax competitiveness while providing adequate revenue for federal government programs. In structural terms, the IMF projects no meaningful improvement in the general government fiscal balance for the next several years.

In spite of the rising deficits and a growing interest burden, the U.S. Treasury retains considerable financial flexibility and the market for U.S. government debt is highly liquid. Federal debt held by the public reached 77.8% of GDP as of end-2018. On a general government basis, the IMF estimates U.S. debt at 106.7% of GDP. The average maturity of federal debt held by the public has gradually increased over the past decade, reaching approximately 5.8 years as of the first quarter of 2019. Domestic and foreign demand for Treasury securities remains strong and is unlikely to diminish. The primary risk to the Treasury market comes from the debt ceiling, which is periodically used by factions within Congress in an attempt to gain leverage in policy debates that may be unrelated to budgetary discipline and the deficit. Detached from the budget cycle, brinksmanship surrounding the debt ceiling periodically raises the specter of a selective default on short-term obligations. Although April tax payments should boost the Treasury’s cash position, the CBO has estimated that the Treasury could run out of room for additional borrowing by the end of FY2019.

Noisy Politics Reflect Highly Open and Robust Political Institutions, but Increasing Polarization Presents a Challenge.

U.S. political institutions remain highly open and transparent, providing a high degree of public accountability and strong incentives for sound governance. Smooth transitions in power, effective checks and balances among the three branches of government, and open public debate are hallmarks of the U.S. system. The United States is a strong performer on governance indicators, which provides stability to macroeconomic policymaking. The electoral system, federal structure, legislative rules, and strict separation of powers generally require bipartisan cooperation to achieve major policy reforms, even when a single party controls the Executive Branch and both houses of Congress. While both parties have at times chafed under these limitations and some potentially productive reforms seem unachievable in the current environment, the system provides a high degree of political stability and respect for the rule of law.

Increased political polarization is nonetheless a challenge. The recent shift in control of the House to the Democratic Party splits control of government and should force compromise on key policy measures in the lead up to the 2020 presidential election. However, the policy agendas differ significantly across the two parties and have been complicated by the recently concluded FBI investigation into whether the Trump Administration conspired with Russian officials to interfere in the 2016 election. While the investigation yielded no evidence of a criminal conspiracy on the part of the administration, both sides continue to characterize the investigation and its findings in starkly different terms. Further battles over access to the report’s unredacted conclusions and other ongoing Congressional investigations may harden the positions of the respective parties and lead to further stand-offs, including, potentially, on the debt ceiling. DBRS remains concerned regarding the apparently widening gulf between the major party platforms and the resulting increase in uncertainty and policy reversibility associated with federal elections.

RATING COMMITTEE SUMMARY

The DBRS Sovereign Scorecard generates a result in the AA (high) – AA (low) range. Additional considerations factoring into the Rating Committee decision included: the size and resilience of the U.S. economy, and the role of the U.S. dollar, U.S. treasury market, and broader U.S. financial system in the global economy. The main points discussed during the Rating Committee include the economic outlook, financial risks, fiscal policy changes, entitlement spending growth, .

KEY INDICATORS

Fiscal Balance (% GDP): -3.8 (2018); -5.1 (2019F); -4.9 (2020F)
Gross Debt (% GDP): 77.8 (2018); 80.7 (2019F); 81.6 (2020F)
Nominal GDP (USD billions): 20,494.1 (2018); 21,344.7 (2019F); 22,198.1 (2020F)
GDP per capita (USD thousands): 62.6 (2018); 64.8 (2019F); 66.9 (2020F)
Real GDP growth (%): 2.9 (2018); 2.3 (2019F); 1.9 (2020F)
Consumer Price Inflation (%, eop): 2.0 (2018); 2.7 (2019F); 2.4 (2020F)
Domestic credit (% GDP): 326.6 (2018)
Current Account (% GDP): -2.3% (2018); -2.4 (2019F); -2.6 (2020F)
International Investment Position (% GDP): -46.6 (2018)
Gross External Debt (% GDP): 94.7 (2018)
Governance Indicator (percentile rank): 89.0 (2017)
Human Development Index: 0.92 (2017)

Notes:
All figures are in USD unless otherwise noted. Public finance statistics reported on a general government basis unless specified. Public finance data based on federal deficits and debt held by the public unless otherwise specified. Governance indicator represents an average percentile rank (0-100) from Rule of Law, Voice and Accountability and Government Effectiveness indicators (all World Bank). Human Development Index (UNDP) ranges from 0-1, with 1 representing a very high level of human development.

The principal applicable methodology is Rating Sovereign Governments, which can be found on the DBRS website www.dbrs.com at http://www.dbrs.com/about/methodologies. The principal applicable rating policies are Commercial Paper and Short-Term Debt, and Short-Term and Long-Term Rating Relationships, which can be found on our website at http://www.dbrs.com/ratingPolicies/list/name/rating+scales.

The primary sources of information used for this rating include OMB, CBO, U.S. Treasury, Federal Reserve System, Bureau of Economic Analysis, Bureau of Labor Statistics, Oxford Economics, IMF, World Bank, UN, and Haver Analytics. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This rating was not initiated at the request of the rated entity.

The rated entity or its related entities did participate in the rating process for this rating action. DBRS did not have access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

This rating is endorsed by DBRS Ratings Limited for use in the European Union. The following additional regulatory disclosures apply to endorsed ratings:

The last rating action on this issuer took place on April 30, 2018.

Solely with respect to ESMA regulations in the European Union, this is an unsolicited credit rating. This credit rating was not initiated at the request of the issuer.

This rating included participation by the rated entity or any related third party. DBRS had no access to relevant internal documents for the rated entity or a related third party.

Generally, the conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. DBRS’s outlooks and ratings are monitored.

For further information on DBRS historical default rates published by the European Securities and Markets Authority (“ESMA”) in a central repository, see: http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Lead Analyst: Thomas R. Torgerson, Co-Head of Sovereign Ratings, Global Sovereign Ratings
Rating Committee Chair: Roger Lister, Chief Credit Officer, Global FIG and Sovereign Ratings
Initial Rating Date: 8 September 2011

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