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Morningstar Economist Predicts U.S. Downgrade Despite Debt Deal

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Whatever the members of the House and Senate do Monday night with the deficit ceiling and deficit-trimming bill that is being put to a vote, the U.S. is not out of the woods yet, according to Morningstar Investment Management economist Francisco Torralba.

Torralba, in an interview with On Wall Street, said the compromise budget trimming measure, which would initially cut $900 billion in expenditures and then another $1.5 trillion to either be voted on later or imposed as across-the-board cuts, are not enough. And, absent either more cuts or tax increases to satisfy the rating agencies -- especially Standard & Poor's -- they could lower the U.S. AAA rating as early as this month to a AA.

“What the credit agencies want to see is a stabilized or flat debt-top-GDP ratio,” explained Torralba, “and that is not what you get with this deal.”

He notes that even if the full $2.4 trillion in cuts end up getting made, the U.S. budget deficit would continue to climb, moving the debt/GDP ratio to above 100% in a few more years.

“S&P has calculated that the U.S. needs to cut $4 trillion from the deficit over the next few years to be in good fiscal shape,” said Torralba. “So I think we’re going to see S&P go ahead and cut the rating.”

He added, “I can’t tell you what Moody's and Fitch will do. S&P has been more aggressive about this. It’s possible that the other two agencies will not lower the AAA rating, at least in the near term. So maybe some people will say that the U.S. still has its triple-A rating. But it would not be the same.”

Torralba said he thought the sharply divided Congress had “don the best they could, given where we are in the election cycle, and given who we have in Congress,” but he said it simply wasn’t enough.

Another concern expressed by Torralba is the timing of the cuts. “If these budget cuts end up being front-loaded,” he warned, “then what it is is an implicit fiscal headwind for the economy.”  He explained, “If you have fewer transfer payments and less public spending, you get more layoffs, and people cut their spending. That would reduce growth and reduce tax revenues, which would also increase the deficit.”  

He said, “That’s why you need some mechanism to cut minimally in the early years, and then more later, after the economy has picked up.”

While Torralba expressed confidence that the U.S. sovereign rating is going to take a hit, he added that he did not think that the consequences would be as dire as some have suggested.  “I think a downgrade to AA has already been priced into the market, and also the interest rate on a AA rating is not that different from the rate for an AAA rating.”  He added, “You’re also not going to see a flight from U.S. Treasuries, because no other instrument has the liquidity of U.S. Treasuries.”



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