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Debt downgrade still possible despite deal

A bill aimed at reducing future deficits by $2.1 trillion, expected to be signed into law,  might not be enough to avert a downgrade of the nation's top-notch credit score.
/ Source: staff and news service reports

A bill aimed at reducing future deficits by $2.1 trillion, signed into law by President Barack Obama Tuesday, might not be enough to avert a downgrade of the nation's top-notch credit score by at least one of the major rating agencies.

All three agencies had warned of a potential downgrade, although Moody's late Tuesday affirmed its top Aaa rating for U.S. debt, saying the new law has  "virtually eliminated the risk" of default.

But Moody's assigned a negative outlook for the United States, meaning it could still downgrade the securities, although probably not anytime soon. Moody's said there would be a risk of downgrade if there is "a weakening in fiscal discipline, a deterioration in the economic outlook or if Congress fails to adopt more deficit-reduction measures in 2013.

A second major agency, Fitch, said it would complete its review of the nation's sovereign debt rating by the end of August and did not rule out a downgrade.

"While the agreement is clearly a step in the right direction, the United States, as in much of Europe, must also confront tough choices on tax and spending against a weak economic back drop if the budget deficit and government debt is to be cut to safer levels over the medium term," Fitch said in a statement.

David Riley, Fitch's top analyst, told Reuters the company also was concerned by a sharp downward revision in economic growth figures reported Friday.

"There could be a rating action which could include a revision of the outlook," Riley said. "I certainly couldn't rule that out."

Standard & Poor's, the third major agency, has so far declined to comment. The agency has warned that the nation's credit rating would be subject to a downgrade without a credible deficit-reduction package worth $4 trillion over 10 years. The package agreed to by congressional negotiators falls well short of that mark.

Treasury Secretary Timothy Geithner said earlier he was not sure whether the bitterly fought debt agreement would be enough to avoid a downgrade of the U.S. top-tier credit rating.

Geithner said the ratings agencies were "going to take a careful look" at whether Washington politicians have the will to act to bring deficits under control.

"It's not my judgment to make" whether the deal is enough to avoid a downgrade, he said in an interview with ABC News that aired Tuesday.

The Dow Jones industrial average fell more than 265 points, dropping below 12,000, partly on concerns about a potential downgrade.

Geithner added that the battle over the debt limit and the threat of default had damaged confidence in the economy, but said he did not think there was a significant risk of a double-dip recession.

"I think this is a good result but a terrible process," he said. "And ... I think as the world watched Congress step up to the edge of the abyss, it made them really wonder whether this place can work. But this is a good deal. It's a good agreement."

William Gross, managing director of bond giant PIMCO, was unimpressed.

"Nothing in the Congressional compromise reached over the weekend makes a significant dent in our $1.5 trillion deficit," he said in a  note to clients. "'Out year' fantasies, as opposed to 'current year' realities, is an apt description of the spending cuts that characterize this compromise."

Ironically, after all the concern about the potential economic cost of a downgrade, some analysts are now predicting that a downgrade might not make that much difference.

"Market participants have the same information that ratings agencies do," said Michael Moran, chief economist at Daiwa Securities America in New York. "(That information) should already be reflected in interest rates."

The bond market is the ultimate arbiter of sovereign debt worries, and low U.S. yields suggest none of the anxiety that sent Greek yields soaring during that country's fiscal crisis.

Investors see the United States in a much different situation than crisis countries such as Greece. Awash in debt though it is, the United States is still able to pay its bills while Treasury bonds remain liquid and in demand.

Benchmark 10-year yields now stand at 2.74 percent, which is just 0.7 percentage point from the all-time low and follows weeks of high-tension haggling and fears political paralysis could result in a default.

Historical experience suggests a downgrade would produce none of the bond-market angst some fear. Japan lost AAA status more that a decade ago and it has some of the lowest interest rates in the developed world.

As it was with Japan, the big issue for markets is the weak U.S. economy, which could slow further due to the spending cuts in the deficit-cutting deal.

This fiscal restraint could curb spending, job growth and inflation -- the biggest drivers of bond yields.