DBRS Morningstar Confirms United States at AAA, Trend Remains Stable

DBRS, Inc. (DBRS Morningstar) confirmed the United States of America’s (U.S.) Long-Term Foreign and Local Currency – Issuer Ratings at AAA. At the same time, DBRS Morningstar confirmed the Short-term Foreign and Local Currency – Issuer Ratings at R-1 (high). The trend on all ratings is Stable.

KEY RATING CONSIDERATIONS
The Coronavirus Disease (COVID-19) pandemic and associated public health response has unleashed one of the swiftest economic downturns in U.S. history. Economic data remained robust through end-February, with continued strong job creation and unemployment at a record low of 3.5%. However, from mid-March to April 23rd, over 24 million Americans filed an initial unemployment insurance claim. An additional 1.6 million dropped out of the labor force in the month of March. Unemployment is likely to peak in the 15-20% range, possibly in early May.

Notwithstanding this difficult environment, the Stable Trend reflects DBRS Morningstar’s view that the resilience of the U.S. economy, institutions and financial markets will continue to provide support to the rating. Though in the midst of an unprecedented global downturn, the flexibility, diversification and resilience of the U.S. economy remains a core credit strength. The role of the U.S. dollar in international markets stems from the large size of the U.S. economy and the strength of its governing institutions. A sizeable structural fiscal deficit has prevailed for most of the past decade, and the coronavirus shock will cause further deterioration in public finances. Further progress is needed over the medium-term to reduce projected deficits associated with entitlement spending. Nonetheless, with long-term interest rates at low levels, particularly in real terms, the federal government has additional time to reduce the federal budget deficit without generating downward pressure on the U.S. sovereign rating.

Though the situation varies in intensity across different parts of the country, there has been clear progress in slowing the spread of the virus through social distancing and related measures. There are some early signs in the most affected states that hospital admissions and the number of new cases are beginning to decline. The U.S. is now by far the global leader in the number of confirmed cases and deaths, but still well behind a number of European economies on a per capita basis. The Trump Administration’s overall strategy for reopening the economy takes a local government-driven approach which implies a phased and uneven reopening. Restrictions on travel, non-essential business and large gatherings will ease only gradually. Continued progress in developing therapies – or even better, a vaccine – could improve the outlook significantly. Otherwise, the risk of renewed outbreaks will remain on the horizon for some time to come.

RATING DRIVERS
Near-term pressure on the U.S. rating appears unlikely. Nonetheless, triggers for a possible downgrade include: (1) a failure to reduce projected deficits over the medium-term, which could limit fiscal flexibility in future downturns; (2) a material deterioration in economic and financial resilience, including potential permanent scarring from the current pandemic and the associated policy response; or (3) the use of the debt ceiling as a means of pressuring political opponents, which could raise questions about the willingness of the U.S. government to pay its obligations on time and in full.

RATING RATIONALE

An Unprecedented Downturn With Limited Visibility Around Virus Containment

The U.S. economy entered 2020 on a strong footing. With unemployment at 3.5%, near record lows, growth in the fourth quarter slowed to 2.1%. DBRS Morningstar expected the economy to continue to slow in 2020, but gradually. Indeed, high frequency data including employment and wages for the first two months of 2020 suggested continued positive momentum. In March, however, as the coronavirus initially spread from Asia and subsequently spread rapidly through numerous U.S. states, limited travel restrictions and early closures of universities and other large group venues quickly gave way to extensive city- and state-wide closures. Initial claims data point to a cumulative 20 million newly unemployed workers in just over one month, reflecting an unprecedented drop in economic activity and household spending.

Just as new hospitalizations appear to be on a downward trend, initial unemployment claims have also come down slightly from their record-high peak. Discussions are underway regarding thresholds and benchmarks for reopening the economy, even as experience in Asia suggests that a second wave of new cases could result. Provided there is adequate progress in expanding testing and treatment capacity, a gradual reopening and managed resurgence in cases may be the least damaging outcome from a credit standpoint. Allowing for some resumption of economic activity in areas where the spread of the virus is better contained, while retaining needed precautions to protect high risk individuals and curb the spread in regions where capacity remains stretched. Nonetheless, this environment will likely inhibit somewhat the economic recovery and could lead to a renewed downturn if any resurgence gets out of hand.

Notwithstanding the dire outlook for growth in 2020, DBRS Morningstar continues to view the resilience of the U.S. economy as a key credit strength and the building block assessment for Economic Structure and Performance remains ‘very strong.’ As the largest economy in the world with high per capita income, high levels of wealth, and an innovative and dynamic private sector, medium-term growth prospects are likely to remain strong. The pandemic will nonetheless prove to be a major test for U.S. consumers and businesses, and unemployment may remain elevated well into 2021. The IMF expects growth of -5.9% in 2020, followed by a strong rebound in 2021 (4.7%). DBRS Morningstar’s moderate scenario is predicated on a more optimistic assumption about 2020 growth (-3.5%), but also incorporates a weaker recovery going into 2021 (3%). Much will depend on the speed with which the state and local governments are able to reopen their economies without an uncontrolled resurgence in cases.

The U.S. Financial System is in a Strong Position, But Risks From the Corporate and Household Sectors are Rising

Federal Reserve actions have contributed to ease financial stresses and will lend support to the economic recovery. Two successive emergency rate cuts in March took short-term interest rates down a cumulative 150 basis points, with the lower limit back at zero. The Fed has also used open market operations to curb market volatility and provide needed liquidity. A range of facilities have emerged once again, backstopped by the U.S. Treasury and in an echo of the 2008-09 financial crisis, to ensure adequate access to credit among corporate and state borrowers. U.S. banks have a strong starting capital position and are playing an important role in distributing government support to keep viable companies afloat. Nonetheless, the sudden closures of a wide range of non-essential businesses, and the number of smaller businesses with limited access to bank credit will make it difficult to extend the needed support.

With a range of commercial establishments shut down or operating well below capacity, the sharp drop in revenue and cash flows has already generated a material increase in arrears on supplier payments, commercial leases and mortgages. Due to a sharp drop in fuel consumption, oil prices and producers are also under stress. Hotels, restaurants and some small businesses have benefited from forgivable loans extended through the Paycheck Protection Program (PPP), which disbursed $350 billion in pandemic assistance loans within just two weeks. Congress last week approved another appropriation to augment the program’s funding and set aside $60 billion for community lenders serving smaller enterprises. The funding will certainly limit stresses in the near term, but gaps in the support are already evident. Similarly, many households will be somewhat insulated from these stresses, due to a generous but temporary augmentation and easing of eligibility requirements for unemployment assistance. However, in the absence of a largely contained spread and robust economic recovery during the second half of the year, business and consumer delinquencies are likely to rise significantly. Stresses on commercial real estate prices appear likely given the impact on businesses; residential real estate could also experience a downturn in regions with large numbers of permanent job losses.

A Weak Fiscal Position, Compounded by Coronavirus, Exacerbates Medium-Term Challenges.

In 2019, the U.S. federal deficit was 4.6% of GDP. On a general government basis and in structural terms, the IMF has estimated the 2019 deficit at 5.8% of GDP. Efforts to reduce corporate and personal income taxes combined with a lack of spending restraint has prevented further progress on fiscal consolidation at a time when the U.S. economy has been operating slightly above potential. The Congressional Budget Office (CBO) last updated its projections in March, prior to the widespread business closures. Based on policies as of that time, the CBO expected the federal deficit to remain around 4.5-5.0% of GDP for the next decade, with debt held by the public gradually increasing from roughly 80% of GDP to nearly 100% of GDP by 2030. The CBO expects the U.S. Coronavirus Aid, Relief and Economic Assistance (CARES) Act to add $1.8 trillion to the deficit (8.1% of projected 2020 GDP) over ten years, with most of the impact appearing in 2020 and 2021 fiscal results. Estimates are subject to considerable uncertainty, depending in part on the level of unemployment between now and July 31 when its provisions expire. Additional legislation has been approved by the House and Senate to augment the PPP and provide additional health sector funding, at an estimated cost of $484 billion. Authorities have signaled that additional legislation may be forthcoming to address other needs.

With 2020 elections just six months away and in the context of a deep recession, appetite for fiscal restraint appears limited. The immediate imperative of lending support to affected households and businesses will guide policy this year, but also increase the importance of a plan to address long-term fiscal challenges. Due primarily to rising mandatory spending and interest costs, outlays are expected to rise from 21.3% of GDP in 2020 to 23.4% of GDP in 2030. There are disagreements between the political parties on how to address the long-term imbalance in social security, on an overall approach to health care reform, and on how to strengthen U.S. tax competitiveness while providing adequate revenue for federal government programs. Once the coronavirus recession has ended, additional efforts to address these medium-term challenges will be needed.

Despite high and rising debt levels, the U.S. Treasury retains considerable financial flexibility and the market for U.S. government debt is highly liquid. Federal debt held by the public reached 79.2% of GDP in 2019. On a gross general government basis, the IMF estimated debt at 106.2% of GDP as of 2019. With additional fiscal measures passed this week and depending on the depth of the economic downturn, DBRS Morningstar expects gross general government debt to reach close to 130% of GDP within the next few years. The average maturity of federal debt held by the public has gradually increased over the past decade, reaching 5.8 years as of end-2019. Although the level of government debt is high, U.S. Treasury bills and bonds function as the major global reserve asset, supported by a highly credible monetary policy and robust legal protections for global investors in U.S. debt markets. This combined with the extraordinary flexibility of the U.S. economy and strong countercyclical demand for U.S. Treasury obligations makes the U.S. highly resilient to debt shocks. Together, these considerations support our assessment of the Debt & Liquidity building block.

Resilient External Accounts Due to the International Role of the U.S. Dollar

During 2019, the U.S. current account deficit has remained broadly in line with its decade-long average of 2.5% of GDP. The deficit shrunk in the fourth quarter, nearing 2.0% of GDP, mainly reflecting a decline in goods imports and following the September 2019 escalation of tariffs on Chinese goods. Trade frictions with China have led to a shift in bilateral trade patterns, but these have had a limited impact on the overall trade deficit. In March 2020, the U.S. dollar strengthened significantly due to rising global risk aversion, particularly against commodity and emerging market currencies.

Capital flows into and out of the United States remain highly diverse and resilient. The pace of global reserve accumulation has remained subdued since 2014, but the role of the dollar and the U.S. Treasury market as reserve assets is unlikely to change dramatically. DBRS Morningstar considers the dollar’s role in foreign exchange markets and in international transactions, combined with the attractiveness of the United States as a preeminent global financial center, to be a key credit strength. These factors significantly reduce the risks associated with external deficits and debt and lend support to this building block assessment.

Primary Elections Have Taken A Back Seat to the Pandemic but the Campaign Should Heat Up In the Fall

U.S. political institutions are highly open and transparent, providing a high degree of public accountability and strong incentives for sound governance. Smooth transitions in power, effective checks and balances among the three branches of government, and open public debate are hallmarks of the U.S. system. The electoral system, federal structure, legislative rules and strict separation of powers generally require bipartisan cooperation to achieve major policy reforms, even when a single party controls the Executive Branch and both houses of Congress. While both parties have at times chafed under these limitations, the system provides a high degree of political stability and preserves a strong rule of law.

Increased polarization is nonetheless a challenge, and weighs on DBRS Morningstar’s assessment of this Building Block. Low levels of trust between the two main parties combined with a divided electorate have generally limited compromise and stymied progress on reforms. Both parties have displayed an unwillingness to compromise due to the diverging priorities of their respective party base. Policy agendas differ significantly across the two parties, generating considerable uncertainty with regards to future policy changes. Agreement has been easier to achieve in relation to the massive support legislation in support of households and businesses during the pandemic, but making tough tax and budget decisions over coming years will likely prove contentious. The federal debt ceiling has been suspended until 2021, but appears likely to resurface as a source of leverage in upcoming budget battles.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments: https://www.dbrsmorningstar.com/research/360384/.

DBRS Morningstar notes that this press release was amended on June 25, 2020 to include the link to the current methodology.

Notes:
All figures are in USD unless otherwise noted. Public finance statistics reported on a general government basis unless specified.

The principal methodology is the Global Methodology for Rating Sovereign Governments (September 17, 2019) https://www.dbrsmorningstar.com/research/350410/global-methodology-for-rating-sovereign-governments.

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

The primary sources of information Used for this rating include BEA, OMB, U.S. Treasury, Federal Reserve, CBO, IMF, World Bank, UN, and Haver Analytics. DBRS Morningstar considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This rating was not initiated at the request of the rated entity.

The rated entity or its related entities did not participate in the rating process for this rating action. DBRS Morningstar did not have access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

This is an unsolicited credit rating.

This rating is endorsed by DBRS Ratings Limited (DBRS Morningstar) for use in the European Union. The following additional regulatory disclosures apply to endorsed ratings:

Each of the principal methodologies/principal asset class methodologies employed in the analysis addressed one or more particular risks or aspects of the rating and were factored into the rating decision, Specifically,
Rating Sovereign Governments, September 17, 2019

The last rating action on this issuer took place on October 25, 2019.

Solely with respect to ESMA regulations in the European Union, this is an unsolicited credit rating. This credit rating was not initiated at the request of the issuer.

With Rated Entity or Related Third Party Participation: NO
With Access to Internal Documents: NO
With Access to Management: NO

Generally, the conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. DBRS Morningstar’s outlooks and ratings are monitored.

For further information on DBRS Morningstar historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Lead Analyst: Thomas R. Torgerson, Managing Director, Co-Head of Sovereign Ratings
Rating Committee Chair: Roger Lister, Managing Director, Chief Credit Officer, Global FIG and Sovereign Ratings
Initial Rating Date: September 8, 2011

For more information on this credit or on this industry, visit www.dbrsmorningstar.com.

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