May 25, 2023
US Must Make Its Mid-June Interest Payment to Avoid Downgrade, Moody’s Says
(Bloomberg) -- With investor attention on the US sovereign credit rating rising as the federal government gets ever closer to running out of cash, Moody’s Investors Service says that a mid-June payment of interest on Treasuries will be critical for maintaining the top, AAA grade.
On June 15, the Treasury Department is due for about $2 billion in interest payments. Treasury Secretary Janet Yellen warned Sunday on NBC that “the odds of reaching June 15th, while being able to pay all of our bills, is quite low” if Congress doesn’t raise the debt limit.
“That’s a really important date for us,” William Foster, a senior vice president at Moody’s, said in an interview Wednesday. While the interest payment is relatively small, “if it was missed, that’s a default. We’d downgrade the rating by one notch from AAA to AA1,” he said.
Foster emphasized that Moody’s does anticipate that Congress and the White House will strike a deal to raise or suspend the debt limit before the Treasury exhausts its special accounting measures to keep within the ceiling. Yellen has advised the Treasury risks running out of cash as soon as June 1.
While Fitch Ratings also has that expectation, late Wednesday it placed its AAA credit rating for the US on watch for a potential downgrade. Moody’s currently has a stable outlook on its AAA rating.
The AAA rating at Moody’s wouldn’t be restored unless Congress overhauled the current debt-limit legislation, according to Moody’s.
“At that point, the debt limit is no longer a frustration of fiscal policymaking that leads to brinksmanship – it resulted in a default,” Foster said. “And we’d need to reflect that permanently in the rating. To bring it back to AAA, there would have to be significant reform of the debt-limit rule so that it’s no longer a material risk to default” going forward — or axing the rule, he said.
The issue is a focus for investors given the history of 2011, when Washington was in a similar partisan battle over raising the debt limit. S&P Global Ratings cut the US from AAA, in a move that roiled financial markets round the world.
For Moody’s, the key issue is whether the Treasury — if it does go past the so-called X-date when it runs out of sufficient cash — keeps up with its servicing of Treasury securities.
Yellen at an event on Wednesday said, “I’m not going to get into what exactly is possible and what is not possible” with regard to paying some things instead of others. Even so, the expectation at Moody’s and across Wall Street is that the Treasury would indeed prioritize federal debt servicing.
“We consider a default to be a missed interest or principal payment,” Foster said. After a downgrade following any June 15 failure to pay interest, the firm “would keep the rating under review for further downgrade until the default is cured.”
Fitch has indicated that failure to pay other federal obligations, besides Treasuries, would be incompatible with a AAA rating.
As for S&P, it has also been anticipating that Congress would ultimately raise the debt ceiling before the Treasury lost its ability to fully fund the government. As of a March report, it continued to rate the US at AA+ with a “stable” long-term outlook. An S&P spokesperson Thursday confirmed that report continues to be the firm’s most current views.
Another firm, DBRS Morningstar, took similar action to Fitch on Thursday, putting the AAA grade for the US “under review with negative implications,” while still anticipating Congress to act in time.
Principal payments are less of a concern for observers, because the Treasury sells fresh debt to pay off maturing. Only if it ran into trouble with investors fleeing its auctions would that then become an issue.
If the Treasury did miss the June 15 payment, “we’d expect the default to be cured within a few days – because the political and financial market fallout would then force Congress to act,” Foster said. “And at the same time, we’d expect the debt limit issue to be resolved prior to the next interest payment,” which is due June 30, he noted. “In that case, we’d stabilize the outlook and the rating would be AA1.”
©2023 Bloomberg L.P.