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S&P's Prescient Warning on America's Fiscal Unpredictability

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S&P Global Ratings is proving to be a better predictor of U.S. partisan political discord than an adjudicator of creditworthiness in the eyes of the bond market.

Almost six years after revoking its AAA rating for the U.S., the credit arbiter’s rationale for the downgrade remains eerily prophetic. Another showdown over the debt ceiling looms, with the Treasury poised to run out of money by early October unless lawmakers agree to extend the statutory limit on the nation’s borrowing.

(Related: Under Attack by GOP, Former CBO Heads Ask for Agency Respect)

 Back in August 2011, S&P warned that “the effectiveness, stability, and predictability of American policy making and political institutions have weakened at a time of ongoing fiscal and economic challenges to a degree more than we envisioned.” The fact that some lawmakers were willing to let the government default despite the unquestionable ability of the U.S. to service its debt was even more worrisome to S&P.

What’s confounding this time around is that Republicans control both houses of Congress, as opposed to during the debt ceiling conflicts in 2011 and 2013, when they were the minority party. The Trump administration has asked Congress to raise the ceiling, but it is running into the same complications the Obama White House encountered: lawmakers, mostly Republicans, who want to use the debt limit as leverage for controversial policy changes.

As it was then, investors acting upon the view that the world’s largest economy was a less creditworthy borrower have made out poorly. Yields on benchmark 10-year Treasury notes sank to record lows following the 2011 ratings reduction. Back then, U.S. government debt was — in that instance, ironically — a beneficiary of a flight to safety, with dollar-denominated assets generally outperforming. More than halfway through 2017, yields have declined year-to-date.

The investment backdrop for much of the past six years has been marked by fiscal inaction and monetary support from Federal Reserve. While the former dynamic endures, as foreseen by S&P, the coming disappearance of the latter constitutes a “key challenge for asset markets,” according to the Institute of International Finance. Compounding the fiscal worries is that in the meantime, as Bloomberg Intelligence Analyst Ira F Jersey notes, the partisan gap between the two parties has swelled.

“The implication for a debt ceiling deal is that compromise may be more difficult to find today than it even was during the 2011 and 2013 debt-ceiling crises,” he writes.

The health care debate has also revealed “material fissures” within the Republican ranks, Bank of Montreal strategists Ian Lyngen and Aaron Kohli wrote, with legislators unable to agree upon a repeal and replacement bill for Obamacare — or even a straight repeal. To be sure, the failure of a unified government to swiftly and smoothly accomplish its policy goals is hardly peculiar to this administration, as a former reality T.V. star once observed.

The possible upcoming showdown over the debt ceiling promises to be “a difficult affair,” according to the BMO analysts, with markets already beginning to price in the potential ramifications of a drawn-out debate.

S&P affirmed its AA+ rating for the U.S. after the presidential election, saying the outlook was stable. The firm assigned a negative outlook after the 2011 downgrade.

The most recent major debt-ceiling showdown, which was accompanied by a government shutdown in October 2013, had a relatively limited impact on markets aside from idiosyncratic moves in Treasury bills. The 2011 debt limit saga occurred amid a relatively widespread retreat in risk assets, coinciding with an escalation of Europe’s sovereign debt crisis — which itself would elicit chiding from S&P.

In light of its disputed track record on the U.S., perhaps observers should take heed of S&P’s latest foray into the political realm. In a December 2016 report, Moritz Kraemer, the chief sovereign ratings officer, warned that Donald Trump’s election victory and the Brexit vote in the U.K. could herald the onset of regressive convergence for political systems in advanced economies.

“It may no longer be possible to separate advanced economies from emerging markets by describing their political systems as displaying superior levels of stability, effectiveness, and predictability of policy making and political institutions,” he cautioned.

Though S&P believes U.S. political institutions have weakened, however, it’s clear the ratings company doesn’t believe they’ve vanished. Lisa Schineller, managing director covering the Americas at S&P Global Ratings, recently highlighted the probe into Russia and the firing of former FBI director James Comey as evidence that the U.S. credit rating remains underpinned by a strong institutional presence.

“We had expected post the election that these checks and balances would also be playing a role in supporting and informing policy execution given the lack of experience of the administration,” Schineller said. That’s happened “in a very active way.”

Schineller wasn’t available to respond to requests for additional comment.

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