Deficit deadlock: US looks at another humiliating downgrade

New York: There are concerns over the chance of downgrades to the US credit rating as the Congressional deficit-reduction Super Committee on Monday said it had failed to reach an agreement on slashing the US budget gap.

The gridlock in the US is coming at a bad time, with all the problems in Europe. The Dow finished down 248.85 points, or 2.1 percent, at 11,547.31, the lowest close since 20 October as investors reacted to the deadlock in Congressional deficit talks. The market took a hit, and is expected to fare worse, as the Super Committee inches closer to the 23 November deficit-cutting deadline.

If the Super Committee can’t agree on how to cut over a trillion dollars from the federal debt, then automatic cuts kick in — cuts the American public doesn’t want to see. A failure to reach a deal would result in $1.2 trillion in automatic spending cuts over 10 years starting in January 2013, in US domestic and military programmes. The Pentagon is on edge, bracing for over half a trillion in automatic cuts.

Economists are predicting that no deal will mean another credit downgrade just like the humiliating one America saw following the debt ceiling debacle this summer. In August this year, Standard & Poor’s stunned America by cutting its credit rating for the first time in history. The ratings agency said it cut America’s top AAA rating by one notch to AA-plus as policymaking was not stable or effective as needed to address the current economic challenge.

“After months of hard work and intense deliberations, we have come to the conclusion today that it will not be possible to make any bipartisan agreement available to the public before the committee’s deadline,” Democrat Senator Patty Murray and Republican Jeb Hensarling, the co-chairs of the Joint Select Committee on Deficit Reduction, said in a statement.

The blame game

The political blame game has already begun. The White House said on Monday that only Congress could have produced a solution to America’s fiscal crisis, while Republicans said President Obama showed a terrible lack of leadership.

One of Obama’s chief Republican rivals, Mitt Romney, said what was most disappointing about the panel’s failure was that Obama showed “no involvement with the process.”

Downgrades to the US credit rating

Standard & Poor’s has that indicated a further downgrade could happen within two years if US debt grows at a faster trajectory than anticipated.

“There’s a sense that the US economy is looking down the barrel of a gun but (Washington) cannot figure out what to do,” Peter Kenny, managing director at Knight Capital Group told The Wall Street Journal. “These downgrades are coming, as sure as the sun comes up tomorrow. They’re a foregone conclusion.”

Daniel Clifton, a policy strategist with Strategas Research Partners, also predicted further downgrades, “a first downgrade from Moody’s and Fitch and possibly a second downgrade from S&P."

“Even with the automatic cuts coming into place, the US is facing a rising debt to GDP ratio,” Clifton said in a note to clients. “In light of the failure of the Super Committee, questions will legitimately be raised whether Congress can deliver on the remaining $2 trillion of savings needed to stabilise the US debt to GDP ratio.”

Dollar under pressure

A failure to come to an agreement on significant deficit reduction has not only spooked the stock market but threatens a decline in the US dollar. The forex market is also focused on how European authorities can come up with measures to contain the region’s debt crisis.

“Our base case is the Super Committee agreeing on $1.2 trillion of cuts or a smaller sum with the rest taken care of by automatic cuts,” wrote David Woo, head of global rates and currencies research at Bank of America Merrill Lynch. “Should the Super Committee remain deadlocked and propose nothing, we would expect the US dollar to come under moderate selling pressure of 1-2 percent.”