DBRS Morningstar Confirms United States at AAA, Stable Trend

DBRS, Inc. (DBRS Morningstar) confirmed the Long-Term Foreign and Local Currency – Issuer Ratings of the United States of America 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 U.S. federal government has continued its highly aggressive fiscal response, seeking to mitigate the impact of the COVID-19 pandemic on the economy. A solid recovery appears to be underway, with confidence gradually returning as vaccinations continue to reach between 2-3 million Americans per day. Some activity restrictions remain in place and a few regions are still experiencing rising caseloads and hospitalizations among unvaccinated groups. Nonetheless, the U.S. economy appears primed for recovery as long as pandemic-related fears recede and activity restrictions are gradually withdrawn. Some of the most affected sectors may see only gradual increases in activity. If any variants emerge that are highly resistant to available vaccines, this could pose additional setbacks to the recovery.

The CBO projects a 2021 federal fiscal deficit of 10.3% of GDP, down from 14.9% of GDP in 2020. The deficit is projected to shrink to a more manageable 4.6% of GDP in 2022. This rapid increase in debt has been affordable given extremely low interest rates, but significantly affects long-term projections of interest costs. Furthermore, it is not clear that the scale of the already-passed spending bills is necessary given the strength of the recovery or well-targeted to boost the productive capacity of the economy. In the medium term, the U.S. lacks a clear plan to address mounting spending pressures. Rising interest payments and entitlement spending are expected to put continued pressure on the federal deficit over the next few decades. Left unaddressed, this could ultimately put pressure on the U.S. credit rating.

In spite of the challenges ahead, DBRS Morningstar continues to view the ratings as underpinned by the extraordinary resilience of the U.S. economy, dollar, and financial system. An innovative private sector and world-class higher educational system, combined with high levels of protection for individual civil and religious liberties, remain a significant draw for citizens, immigrants and temporary workers alike. The U.S. dollar and U.S. financial markets remain at the center of world trade and capital flows. Supportive policies from the Federal Reserve have absorbed most of the increased debt issuance from the coronavirus response, enabling the Treasury to finance the increased borrowing at zero net cost for now. Rising indebtedness could ultimately have an impact on growth prospects for the U.S. economy, but U.S. financial flexibility is unlikely to diminish within the foreseeable horizon.

RATING DRIVERS

The ratings could be downgraded due to one or a combination of the following factors: (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

The U.S. Economy Remains Resilient and is Likely to Lead the Global Recovery

The COVID-19 recession was very deep, but U.S. economic performance has been relatively strong in comparison with other major advanced economies. U.S. growth has outperformed the other G-7 economies every year since 2017. 2021 growth is expected to be 6.4%, also the highest among that group. However, there is still a significant degree of underutilization in the labor market. Of the roughly 25 million jobs lost in early 2020, only two-thirds have been recovered. Civilian employment remains nearly 8 million lower now than it was at the beginning of 2020, and of those still looking for a job, most have been looking for six months or more. This suggests a high level of stress within a small segment of the population, particularly lower-income and younger workers.

Notwithstanding some weakness in some pockets of the labor market, household savings is at an elevated level. In February, savings as a percentage of disposable income (3-month moving average) was more than double its pre-pandemic level of 7-8%. This data does not yet account for the latest round of stimulus checks, which previously generated substantial increases in savings. Disposable income gains have contributed to a boom in housing-related spending, even as several other sectors remain well below capacity. In aggregate, U.S. households are poised for an additional increase in spending, but confidence may return only slowly. Continued uncertainty regarding the evolution of the pandemic, continued caution with regard to certain types of spending (i.e., travel, live entertainment, and other highly interactive activities), and continued restrictions on international travel will likely imply only a gradual recovery.

In spite of the substantial pandemic shock, DBRS Morningstar continues to view the U.S. economy as the largest, most resilient, and most flexible economy in the world. This dynamism remains a key credit strength and provides additional uplift to the economic structure and performance building block assessment.

The Federal Reserve and U.S. Financial System Are in a Strong Position To Support to the Recovery

The Federal Open Market Committee (FOMC) is expected to maintain its highly accommodative stance well into 2023. Most FOMC voters see rates remaining at zero well for the next two years, at least. The FOMC commitment to low interest rates is likely to persist until the labor market fully recovers, with equilibrium unemployment estimated at 4%, and with projected PCE inflation of 2.4% in 2021, moving toward the 2% target by 2023. Market expectations have shifted in line with the Fed’s statements. Nominal Treasury rates are roughly at zero out to two years, and the yield premium between the five year nominal Treasury and inflation protected securities of the same maturity has averaged slightly over 2.5% for the past month. With considerable fiscal stimulus in the pipeline, the risk of materially higher inflation cannot be entirely discounted, but the FOMC will likely adjust policy if stronger price pressures emerge due to a tightening labor market.

The Federal Reserve’s balance sheet has also ballooned as result of its response to the pandemic. The initial increase of $1.5 trillion in Treasury security holdings within just two months (March & April 2020) has been followed by an additional $1 trillion increase over the last twelve months. Cumulatively, this amounts to 11% of 2021 GDP. Mortgage-backed securities holdings have increased by an additional $800 billion since February 2020. Other lending and credit facilities increased markedly in the earliest phase of the pandemic, but have already begun to decline as credit from the banking and non-bank financial sector remains widely available. The FOMC has signaled that purchases of Treasury and mortgage backed securities will continue at a steady pace ($120 billion per month in total) until “substantial progress” has been made toward maximum employment and inflation goals.

The broader financial system is also well-positioned to support the economic recovery. Strong credit growth and rising real estate prices in the midst of an economic downturn suggest that financial risks could be rising. Housing prices could undergo a correction in coming years. However, this seems unlikely to be widespread or prolonged in the context of a gradual economic recovery with rising household incomes. Consequently, DBRS Morningstar has given some uplift to our building block assessment for Monetary Policy & Financial Stability. Bank holdings of securities have increased by $1 trillion since February 2020, while commercial lending is up a more modest $240 billion. Consumer lending declined in the early phase of the pandemic as households repaid revolving credit and it has only recently begun to tick upward. Although loan delinquencies have begun to increase, they remain well below stressed levels reached during the last financial crisis and banks have been able to release excess loan loss reserves. DBRS Morningstar remains concerned regarding potential pockets of credit stress within some sectors, but overall bank balance sheets appear well positioned to weather stresses.

Projected Deficits Pose a Long-Term Challenge, but Financial Flexibility Gives Ample Time for Policy Adjustments

The federal government has played a major role in lending support across the economy. This has resulted in double digit deficits in 2020 and 2021. The CBO estimates the federal deficit reached 14.9% of GDP in 2020, and is expected to be 10.3% of GDP in 2021. On a general government basis, the IMF expects deficits of 15.8% and 15.0% in 2020 and 2021, respectively. Automatic stabilizers have been fully utilized but also significantly augmented to provide extra income support to affected households. Support for businesses has also been substantial, though generally restricted to companies willing to incur additional debt to maintain payrolls. The federal deficit is projected to shrink to 3.6% of GDP by 2024, but will remain elevated in structural terms over the medium-term. Over the long-term, interest payments and entitlement spending are expected to increase as a percentage of GDP, potentially crowding out other spending or requiring higher tax rates. Although there are numerous adjustments that could be made to curb the growth in federal deficits, the pandemic response has taken priority and there is a lack of political consensus around how fiscal accounts should adjust in the post-pandemic period.

The Biden administration also has a lengthy list of infrastructure and environmental priorities. This could have a significant fiscal cost, but the administration is looking for ways to raise additional revenue. The added spending on infrastructure could have positive effects on growth over the medium-term, but it is presently unclear how large or how productivity-enhancing the new infrastructure push will be. Coordination with state and local governments often poses a challenge and may hold back progress on some planned investments.

Public debt is rising sharply due to the ongoing pandemic response but should stabilize in the medium-term. According to the CBO’s latest projections, federal debt held by the public will reach 102% of GDP by end-2021. In IMF projections, general government debt is expected to reach 133% of GDP. Debt levels are expected to remain approximately at these levels through most of the next decade, as projected fiscal balances from 2023 onwards are broadly consistent with an estimated debt stabilizing primary balance of around -3%. After 2030, however, long-term projections show more troubling debt dynamics associated with the costs of population aging and higher equilibrium real interest rates.

Short-term treasury bills were issued to fund the initial response, nearly doubling from $2.7 trillion outstanding to $5.1 trillion during Q2 2020, but are gradually being replaced with longer-term issuance. Although long-term yields have risen somewhat, low real interest rates are expected to persist for some time to come, giving ample room for increasing debt issuance in the near- and medium-term with no meaningful impact on debt sustainability. The actions of the Federal Reserve, which in addition to the favorable interest rate environment have increased the size of the Fed’s balance sheet from a mere 6% of GDP in mid-2008 to over 34% of GDP as of March 2021, will continue to provide flexibility. A combination of private sector demand and foreign official demand for safe and liquid debt instruments further supports the Treasury’s capacity to rollover its debt at an exceptionally low cost. These strengths continue to provide uplift to the Debt & Liquidity building block assessment.

Resilient External Accounts Due to the Role of the U.S. Dollar and Global Financial Flows

U.S. external accounts slipped further into deficit during 2020. The U.S. current account deficit declined from 2.2% of GDP in 2019 to 3.1% in 2020. Both imports and exports dropped precipitously at the height of the pandemic, but imports have rebounded more sharply as U.S. growth performance has been stronger than that of its major trading partners. Goods imports have recovered quickly, while services have only begun to recover, as many restrictions on international tourism remain in place and other trade in services has been constrained as well.

The U.S. net international investment position dropped from -51.6% of GDP as of end-2019 to -67.3% of GDP in 2020. The rise in external liabilities reflects in part a weakening dollar, the strong performance of U.S. equity markets, and continued inflows into U.S. capital markets. DBRS Morningstar continues to view U.S. external accounts as benefiting from the unique role and position of the U.S. dollar within international finance. This limits external risks and lends support to the Balance of Payments building block assessment.

U.S. Institutions Serve as an Anchor in Times of Polarized Politics

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 vigorous, 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. This system
generally provides a high degree of political stability and preserves a strong rule of law.

Increased polarization is nonetheless a challenge, and continues to weigh on DBRS Morningstar’s assessment of the Political Environment 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. To the extent that institutional constraints are weakened through the actions of a single party, this could increase policy reversibility. With the debt ceiling suspension ending in July 2021, there is some risk that opposition lawmakers will resort to brinksmanship that weakens confidence in the political commitment to pay all Treasury obligations as they come due, particularly as they seek to constrain the Biden administration’s spending proposals.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments: https://www.dbrsmorningstar.com/research/377638.

Notes:
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.

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 https://www.dbrsmorningstar.com/research/364527/global-methodology-for-rating-sovereign-governments (July 27, 2020). Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings, https://www.dbrsmorningstar.com/research/373262 (February 3, 2021).

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.

The primary sources of information used for this rating include BEA, U.S. Treasury, OMB, CBO, Federal Reserve, IMF, World Bank, OECD, 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 for use in the United Kingdom, and by DBRS Ratings GmbH for use in the European Union, respectively. The following additional regulatory disclosures apply to endorsed ratings:
The last rating action on this issuer took place on October 28, 2020.

With respect to FCA and ESMA regulations in the United Kingdom and European Union, respectively, 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

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. DBRS Morningstar understands further information on DBRS Morningstar historical default rates may be published by the Financial Conduct Authority (FCA) on its webpage: https://www.fca.org.uk/firms/credit-rating-agencies.

Lead Analyst: Thomas R. Torgerson, Managing Director, Co-Head of Sovereign Ratings
Rating Committee Chair: Nichola James, Managing Director, Co-Head of Sovereign Ratings
Initial Rating Date: September 15, 2011

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