S&P Downgrade Not ?Complete Disaster?: Economist

The stunning decision by credit agency Standard & Poor’s to downgrade the United States’ top-notch debt rating should not be a “complete disaster,” according to an expert.

S&P cut the long-term credit rating of the U.S. by one tick from AAA to AA+ with a negative outlook, referring to worries about the budget deficit. The agency warned that the deficit-reduction program recently passed by Congress was insufficient to deal with the government’s massive debt overhang.

The debt-clearance package, agreed to after a contentious battle between Democrats and Republicans, envisioned reducing $2.4-trillion in debt over the next ten years – S&P was hoping for $4-trillion in cuts.

S&P defended the downgrade by lamenting that the government’s debt proposal "falls short of what, in our view, would be necessary to stabilize the government’s medium-term debt dynamics."

On that basis, perhaps the downgrade was not too much of a surprise.

S&P further warned that another downgrade is on the cards -- likely down to AA -- "within the next two years" if, among other things, the aforementioned $2.4-trillion in cuts do not take place.

Paul Dales, senior U.S. economist at Capital Economics in Toronto, said that while the decision by S&P will rock the stock markets when trading opens on Monday, “any spike in Treasury yields and/or fall in the dollar should be relatively short-lived.”

Dales explained that “once the dust settles, attention will turn back to the economic fundamentals, which are certainly consistent with low Treasury yields.”

While conceding that financial markets, already reeling after the past two weeks of carnage, could react very negatively to the downgrade, Dales said he isn’t convinced it will be catastrophic.

For one thing, the new AA+ rating still provides the US with (as S&P itself cited) "an extremely strong" capacity to meet its financial obligations.

Moreover, the loss of the prized AAA rating might not be permanent.

“Australia and Canada are examples of countries that have lost their AAA ratings only to regain them some years later,” Dales noted.

In addition, Dales explained that “a lower credit rating is likely to mean higher borrowing costs and a lower dollar only if other things are equal. If we are right in thinking that a prolonged period of weak economic growth and low inflation will mean that short-interest rates remain low for some years yet, then U.S. Treasury yields will also remain low.”

Any negative market reaction, Dales believes, will be short-term.

“It won't be long before the markets focus once again on the economic fundamentals,” he said.