HR Ratings assigned the long-term rating of HR AAA (G) and the short-term rating of HR+1 (G) for the sovereign debt of the United States of America along with a Stable Outlook

The rating assigned to US sovereign debt is based on our assumption that a formal default on the debt is extremely unlikely if not inconceivable.

MEXICO CITY, MEXICO / ACCESSWIRE / March 15, 2023 / HR Ratings, Credit Rating Agency, registered by the Securities and Exchange Commission (SEC) as a Nationally Recognized Statistical Rating Organization (NRSRO), announced today its issuance of the United States of America sovereign debt, with the long-term rating of HR AAA (G) and the short-term rating of HR+1 (G) along with a stable outlook.

The rating assigned to US sovereign debt is based on our assumption that a formal default on the debt is extremely unlikely if not inconceivable. The unlikeliness of a default is also supported by the role of the US dollar as the global economy’s principal reserve currency, the fact that the totality of the debt is denominated in US dollars and the increasing willingness of the Federal Reserve to purchase substantial amounts of US government debt in the secondary markets. At the same time the strong recent statements on the part of the Federal Reserve expressing its willingness to raise interest rates to levels beyond those currently expected supports the rating and the outlook.

The Stable Outlook, and indeed the rating itself, could suffer a deterioration should we need to change our long-term forecasts to assume a higher level of inflation or deterioration in the relative value of the USD vs. other currencies, in part as a result of a deterioration in the current account. A resolution to the debt limit impasse that does not offer hope of a change in the trajectory of the debt forecasted in this report could also affect the Outlook.

Although formal default on US sovereign debt is difficult to imagine, we regard some form of virtual default through high levels of chronic inflation or currency devaluation as also being highly unlikely although the risk could increase over time. The upsurge in inflation seen in 2021 and 2022 (and likely to moderate in 2023, although remain somewhat elevated) is a negative consideration, especially assuming that in part it might be attributable to excessively expansionist fiscal and monetary policy.

However, in our opinion this is not sufficient to impact our rating given the following: 1) the extraordinary nature of the COVID pandemic which we regard as the principal cause of policy laxness, 2) the role of international factors not related to policy decisions in exacerbating inflation, in particular, supply chain disruptions (in part caused by COVID) and the war in Eastern Europe, and 3) the decisiveness of the Fed’s response once it became apparent that the inflation phenomenon was not as “transitory” as had originally been assumed.

Nevertheless, the current level of public debt to GDP at nearly 100% and our expectation that it will continue to increase could eventually affect this rating. Much would depend upon whether it produces sustained high levels of inflation and/or significant USD devaluation. In this context, the Fed’s policy of quantitative easing has both positive and negative aspects.

On the positive side, Fed policy attempts to keep the economy producing at its full non- inflationary potential through such mechanisms as quantitative easing. The purchase of US debt by the Fed reduces the “crowding out” effect of the need to finance deficits thus facilitating (although not guaranteeing) private sector productive investment.

Quantitative easing also has the effect of reducing “public” debt actually in the hands of the public. Although our debt/GDP metric incorporates all public debt (and does not include intragovernmental debt) not servicing Treasury debt held by the Fed does not necessarily represent default.

On the negative side, quantitative easing can be inflationary by permitting the demand for goods and services, often generated by loose fiscal policy, to outstrip supply. As previously mentioned, inflation and/or currency depreciation can at some point represent virtual default. Consequently, an autonomous central bank following policies to limit inflation is relevant to our credit rating. Thus, the Fed’s interest rate policy is also relevant in our analysis and, in hindsight, was probably too lax for too long a period of time following the financial crisis of 2008-09. Although low interest rates can help stimulate economic growth, including investment, it can also reduce savings which is crucial for investment.

It appears that inflation is now entering a critical stage as the impact of extraordinary factors, such as supply chain issues, have reduced, or faded. Now the question is the degree to which large fiscal deficits and their past, and possible future, de facto partial financing by the Fed will generate an unacceptable level of inflation.

Our analysis assumes a moderate level of economic growth which is not sufficient to prevent the growth of spending relative to GDP and could lead to further demands for government spending. In this context, the decline in labor productivity in 2022 (due to reductions in 1Q and 2Q) would be a significant cause for concern were it to continue. This reinforces the need to ensure that the growing financing needs of the Federal government not crowd out the investment necessary to maintain productivity growth.

Furthermore, given the complicated geopolitical situation we assume rising defense expenditures which will place additional pressures on fiscal policy. We also assume slightly positive real Federal Funds rate which combined with rising primary deficits will lead to growing interest costs. Nevertheless, we do not yet see this as producing a degree of inflation that constitute a risk factor for our credit rating. Rising deficits could lead to somewhat higher current account deficits although at this point in time we do not see this as constituting a threat to the position of the USD as the global economy’s principal reserve currency. Thus far large fiscal deficits have not led to any appreciable weakening of the USD.

Even so, it is important to emphasize that the failure to restrain inflation and the resulting degradation of the currency could increase political polarization and paralysis and eventually lead a change in Outlook to a deterioration in the rating. We assume that the debt limit is ultimately increased although whether this would be accompanied by an agreement that limits the upward trajectory of the debt is not at all clear. However, we do recognize the possibility that before a resolution is reached there might be some failure to meet certain non-debt obligations that would not imply, under our methodology, debt default.

In the following table we provide the principal assumptions in our base scenario that form the quantitative core of our rating process. The data are presented on a fiscal year basis. We assume moderate real GDP growth with a CAGR from 2022 through 2029 of 1.68%. The primary deficit would average 3.58% of GDP while interest costs would average 3.15% but expand substantially from 1.90% in FY22 to 3.62% in FY29. As a result, the overall financial deficit (not shown) would average 6.73% but end at 7.53% in FY29. Public debt as a percentage of GDP would end FY29 at 114.2% of GDP (vs. 97.1% at the end of FY22) assuming a CAGR for nominal GDP of 4.51% with a CAGR for deflator inflation of 2.78% combined with the already mentioned real GDP growth of 1.68%.

Although our formal debt metric for the US is Treasury debt in public hands, the fact that a significant portion of that debt (at the end of FY22 it was 24.4%) was held by the Fed is a relevant consideration. Excluding debt held by the Fed, public debt as a percentage of GDP falls from 97.1% to a still substantial, but much lower 72.7%.

One of our major considerations is inflation. We see CPI inflation trending down to 2.50% which would probably translate into around 2.2% for the PCE, the Fed’s preferred metric. This, of course, would still be above the Fed’s 2.0% target. On a long-term basis from 2022 to 2029 the CPI’s CAGR would reach 3.0% which would be significantly above the PCE. One question is whether the Fed would consider the longer-term inflation metric to be more appropriate as it previously has done when it was significantly below 2.0% before the upsurge in inflation in 2021. As we discuss in detail in our section on interest costs, we assume modest real interest rates, at least with respect to the Fed Funds rate. Thus, a long- term PCE inflation above 2.0% does not translate in our base scenario into a highly restrictive monetary policy, in the long-term.

We believe that the most significant risk in our base scenario is the level of inflation in the context of the assumed primary deficits. Higher inflation would produce higher real interest rates and further increase interest costs as a percentage of GDP. Furthermore, the failure to limit PCE inflation to levels close to 2.0% on a long-run basis could be considered as a form of currency degradation which could require downward revision in the rating.

Finally, we assume that the current account deficit would tend to run above at around 3.25% of GDP. We furthermore assume that this would be largely consistent with the dollar remaining the global economy’s primary reserve currency and with a stable level for the USD relative to other currencies. However, we do not discount the possibility that it could experience some depreciation vs. its currently high levels as we see a reduction in the primary income balance.

Regarding the non-quantitative variables considered for this rating it is important to emphasize the structural strengths that the U.S. possess, including the size of the economy, the development of the financial system, its market size, high institutional and governance strength, high per capita income, and the dynamism of the business environment.

HR Ratings Future Assumptions

• Public Finance projections. Public debt is expected to reach 118.2% of GDP in 2033 with financial deficits averaging 107.5% from FY23 though FY29.
• GDP growth. Long-term real GDP growth is expected at 1.70% with an average deflator inflation of 2.78%.
• Inflation. CPI inflation is projected to stabilize at 2.50% in the long term.
• Monetary policy. We assume that the Fed Funds rate will stabilize at 2.87% (mid-range) while quantitative easing will remain a policy tool should the need arise to encourage growth and support fiscal policy.
• External accounts. The current account deficit would stabilize at slightly at around 3.25% of GDP and be sufficiently supported by the financial and other accounts.

Factors that could downgrade the rating

• Chronic political divisions that impede the ability to timely approve and adequately implement fiscal policy.
• Lower than expected real economic growth that produces political demands for higher levels of government spending and primary deficits.
• Higher levels of inflation that lead to USD devaluation and weakening of the USD as a major reserve currency.
• Geopolitical crises that lead to larger fiscal imbalances, inflation, and currency devaluation or even some form of military conflict.

About HR Ratings

HR Ratings is the leading global rating agency in the Mexican market, issuing more than 2,000 ratings per year, with presence in North America, Latin America, and Europe. We are registered before the SEC (the US regulator), ESMA (the European regulator) and FCA (the UK regulator), allowing us to operate in their regions by following their highest standards. Because of this, and because of the quality of our ratings, we have enjoyed substantial growth year after year. We are well known in the market for the transparency of our methodologies, which reflects the deep knowledge of the asset classes in which we operate. Our methodologies incorporate ESG criteria, while each rating involves a thorough analysis of the entity’s credit quality as we train our team with the support of the CFA Institute. We also have strategic alliances that help us increase our presence across the globe. https://www.hrratings.com/

Contact Information

Mar Fernandez
Communications Analyst
E-mail: [email protected]

Diego Garcia
Communications consultant
E-mail: [email protected]

Please see attached report

SOURCE: HR Ratings