Why Scope Has Never Rated the US AAA

On 5 May 2023, Scope placed the AA credit ratings under review for downgrade. On 29 June, the agency’s AA rating was confirmed but a Negative Outlook assigned – underscoring the view that risks to the United States’ sovereign rating are tilted to the downside during the next 12-18 months. Here’s why:

Increasing Risk Associated With Misuse of the Debt-ceiling Amid Political Polarisation

• The most recent US debt-limit crisis was resolved after Congress approved a last-minute suspension of the debt ceiling until 1 January 2025, avoiding technical default. But the debt limit will bind again in roughly a year and a half, following potentially highly-contested 2024 Federal elections that might further divide the nation.
• The frequency of debt-ceiling stand-offs alongside a recurring, non-negligible possibility of temporary non-repayment during specific and severe episodes constitute unique credit vulnerabilities of the United States relative to the United States’ highly-rated sovereign peers.
• Recurring debt-ceiling crises result in phases of debt distress for the Federal government and dependence on last-minute congressional action to ensure repayment of debt in full and on time. This raises risk over the long run and presents a structural challenge for the rating.

Long-run Governance Vulnerabilities

• Congressional polarisation results in less deliberative legislative processes, raising political brinkmanship and impeding government capacity to address material economic and fiscal challenges.
• Rising political polarisation interacts with debt-ceiling risk, making it more difficult to reach bipartisan solutions addressing severe crises.

Higher Than Normal Fiscal Deficits

• Federal deficits are expected to stay higher than normal in the coming years. The general government deficit declined to 5.5% of GDP last year, down 6.1pps from the previous year, but Scope expects headline budget deficits to widen from 2023, rising to about 6.4% of GDP this year before stabilising around a 6.6% average over 2024-28 (compared with a 4.8% average during 2015-19). In the long run, ageing-related spending constitutes an added risk for the budgetary outlook.

Rising Debt Trajectory

• After two years of declining debt ratios, the US debt trajectory is expected to begin reversing this year, with debt edging sideways to around 121.8% in 2023 before rising to nearly 133% by 2028, reflecting persistent budget deficits outweighing the favourable effects of continued economic growth and higher inflation for longer.
• The Negative Outlook Scope assigned to the US credit rating accounts for challenges to the fiscal outlook, with wider budget deficits than pre-Covid averages alongside rising government debt. Elevated deficits raise risk during debt-ceiling crises, curtailing the space of time the Treasury has for emergency actions in meeting government spending obligations during such crises.

Economic and Banking-system Risks as the Fed Completes Its Tightening Cycle to Cool Inflation

• Rapid tightening of funding conditions has elevated financial-system risk after an extended phase of exceptionally accommodative central-bank policies pushed asset valuations to lofty levels. Debt-service ratios are still moderate compared with their historical averages but non-financial corporate debt stood at a material 78.1% of GDP as of Q4 2022 (albeit off of Q1-2021 highs).
• Further risks to financial stability include decreased liquidity in treasury markets resulting from quantitative tightening, driving up financial-market volatility. Vulnerabilities emerged earlier this year following the failure of several regional banks, partially reflecting regulatory shortcomings alongside the effects of rising interest rates.

External-sector Vulnerabilities

• A current-account deficit of 3.5% of GDP in the year to Q1 2023 amid strong domestic demand for tradeable goods and despite marked pick-up in US oil and gas exports. The current-account imbalance is significantly linked to budget deficits, with the current account expected by the IMF to remain in deficit of above 2% of GDP through 2028. The net international investment liability position of the US amounted to 65% of GDP at Q1 2023, albeit off the 81% at end-2021.

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Dennis Shen is a Senior Director in Sovereign and Public Sector ratings at Scope Ratings GmbH. Keith Mullin, Senior Editor at Scope, contributed to drafting this article.