Moody's Still Cautionary on U.S. Debt

Sep 28, 2009

Fears over any near-term U.S. inflationary pressures may have eased for the moment. Moody’s recently reassured investors that it didn’t see any problem in the near future for the United States and its growing debt (unlike the United Kingdom which is under pressure to adjust its fiscal policies sooner rather than later.)

However, fears about the medium-term fiscal outlook for the United States as the U.S. economy rebounds remain. In recent weeks, the auctions for Treasury securities have been oversubscribed and the interest rates on short-term (and long-term) Treasury securities remain below historical averages. And last year’s concern over the risk of owning Treasury securities (in 2008, the credit default swap rate for Treasury bills increased nearly sevenfold) seems to have subsided for the moment.

Is this good news or just backing away from the very pessimistic view of the bond vigilantes earlier this year?

Moody’s tempered its announcement with a warning about the medium-term outlook for U.S. fiscal policy. Moody’s hinted that it is “conceivable” that a large and wealthy government could be downgraded if it had “a material and irreversible deterioration in its debt conditions over the next five years or so.” This follows on the June announcement that Moody’s thought the U.S. bond rating of AAA (the highest rating) was “safe” but cautioned that it would be at risk if the United States was “unable to bring public debt back to a downward trajectory.” And since U.S. debt, which will approach 60 percent of GDP in 2009 and then grow to 70 or 80 percent by the end of this decade, policymakers would be wise to read between the lines of Moody’s press release and take action on the U.S. medium-term debt.