“The Covid-19 shock is exposing and exacerbating US social, fiscal, economic and institutional weaknesses and at the same time highlighting the benefit the US government draws from issuing the world’s reserve currency,” says Alvise Lennkh, director at Scope Ratings.
“For now, these contrasting credit relevant forces remain balanced at an under-consensus AA rating level assigned by Scope, but the longer the healthcare, labour market and social crises persist, the greater the materiality and irreversibility of their medium-term impact on the US credit outlook will be,” says Lennkh.
Three simultaneous crises state-side
The US faces three simultaneous crises, which are mutually reinforcing due to the country’s weak social safety net.
First, the Covid-19 crisis, which has resulted in more than 100,000 reported deaths, or 28% of the global total. Second, the labour market crisis, which, even after better than anticipated payrolls in May, has still resulted in over 20mn unemployed, or at least a 13% unemployment rate. Third, the latest wave of mass anti-racism protests despite pandemic-related lockdowns risk exaggerating the health and economic crises in addition to already existing socio-political tensions.
These inter-related developments are rating relevant in so far as they are likely to:
- postpone the gradual lifting of containment measures, delaying the return of economic activity in the near-term,
- extend the financial stress of households, businesses and local governments, which will need additional federal fiscal support to compensate for lost income, weakening the country’s already worrisome fiscal outlook over the medium-term, and
- further polarise Congress, impeding bipartisan solutions to address the country’s structural challenges and increasing risks of future government shutdowns and/or politicised misuses of the debt ceiling, the suspension of which ends in July 2021.
Comprehensive budget response and fiscal challenges
So far, the US government has implemented a comprehensive fiscal package to counter the Covid-19 crisis. All told, the approved fiscal support amounts to around USD 3trn, of which about USD 1.8trn (8.3% of GDP) is related to direct fiscal costs.
Moreover, on 16 May, the House of Representatives passed an additional USD 3trn stimulus through the HEROES Act, which, if approved, would increase fiscal spending by another 10% of GDP. While it is unlikely to pass in its current form in the Republican-held Senate, a further significant fiscal support package is likely to be finalised this year to provide much-needed support to the US economy.
As a result, conservatively assuming a GDP decline of around 6-8% this year, the overall fiscal deficit for 2020 is likely to range between 20-25% of GDP. This will increase US gross financing needs to above 40% of GDP and lead to a significant jump in the debt-to-GDP ratio, from 107% in 2019 to around 135-140% in 2020. This compares with expected debt ratios of around 115% for France (AA/Stable) and around 100% for the United Kingdom (AA/Negative) by the end of this year.
US continues to benefit from the dollar’s status and Federal Reserve action
Still, despite this significant deterioration in the economic and fiscal outlook, the US continues to benefit from the dollar’s unparalleled reserve currency status and the associated perception that US treasuries are the world’s safe asset. “This unique strength allows the government to run sustained fiscal deficits with limited concerns over the sustainability of its public finances,” says Lennkh.
In addition, the Federal Reserve is expanding its balance sheet to unprecedented levels, as is also the case in the euro area, Japan and the UK. Since August 2019, the Fed’s total assets have increased from USD 3.8trn to above USD 7trn (around 32% of GDP) at the end of May 2020, which, however, remains below the respective levels of the ECB (40%) and the Bank of Japan (110%).
Thus, despite a significant increase in US funding needs, even if private sector actors do not fully absorb the additional supply of US treasuries, financing conditions will remain accommodative over the forthcoming period given the open-ended purchases of public sector debt securities by the Federal Reserve.
The current yield on the 10Y US Treasury Bond is 0.9%, markedly below the 2019 year-end yield of around 1.9%. In addition, almost 72% of government debt is held domestically, with 11% held by the central bank as of end-2019, a share that will increase given the expansion of the asset purchase programme. “Barring legislative limits to federal borrowing via future use of the debt ceiling, refinancing costs and risks are likely to remain negligible despite the country’s poor fiscal trajectory,” says Lennkh.
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Alvise Lennkh is the Deputy Head of Public Finance at Scope Ratings GmbH.