On September 24, 2024, Moody’s Investors Service issued a report highlighting concerns about the future of the U.S. fiscal profile as the country heads into its 2024 presidential election. Regardless of whether Democrat Kamala Harris or Republican Donald Trump emerges as the victor on November 5, Moody’s anticipates that political challenges and the country’s already substantial debt will continue to deteriorate the fiscal outlook.

U.S. Sovereign Credit Profile Under Pressure

The U.S. fiscal situation has been a growing concern in recent years, with a debt burden that has risen rapidly. Moody’s is the only major credit ratings agency still maintaining the U.S.’s top-tier AAA rating, though the outlook has been negative since November 2023. This move followed Fitch’s downgrade of the U.S. sovereign credit rating from AAA to AA+ in August 2023, joining Standard & Poor’s (S&P), which had lowered the U.S. rating to AA+ back in 2011. The warnings from these agencies have been triggered by repeated instances of political gridlock, most notably during the debate over raising the debt ceiling, which has undermined investor confidence in the U.S.’s ability to manage its debt effectively.

Fiscal Deficits and Debt Burden

Moody’s report paints a troubling picture for the next administration, predicting annual fiscal deficits of around 7% of gross domestic product (GDP) for the next five years. These deficits could balloon to 9% of GDP by 2034, driving the U.S. debt-to-GDP ratio from 97% in 2023 to a staggering 130%. The increasing size of the deficit and growing debt burden are becoming increasingly unsustainable, posing significant risks to the U.S. fiscal strength and sovereign credit profile.

The agency stressed the need for the new administration to implement meaningful policy measures to curtail deficits, rein in borrowing, and slow the rise of interest expenses, which are consuming a growing portion of government revenues. Moody’s report stated, “These debt dynamics would be increasingly unsustainable and inconsistent with an AAA rating if no policy actions are taken to course correct.”

In the absence of necessary fiscal reforms, the U.S. could face further downgrades, which would not only tarnish its credit reputation but also increase borrowing costs, further compounding the fiscal challenges.

Political Polarization and Its Impact

A major factor contributing to Moody’s concerns is the increasing polarization in U.S. politics, which has made it difficult for lawmakers to agree on significant reforms. In recent years, the U.S. Congress has been deeply divided, with Republicans narrowly controlling the House of Representatives and Democrats holding a slight majority in the Senate. This divided government has often led to stalemates on key fiscal policies, including spending and tax reform, making it difficult to address long-term fiscal challenges.

The 2024 election, which will not only decide the presidency but also determine the composition of Congress, is critical for the fiscal future of the U.S. The outcome of these elections will influence whether the next administration can implement the necessary fiscal reforms.

Moody’s report emphasizes that if Congress remains divided after the November elections, it will significantly hamper the new administration’s ability to pass sweeping fiscal reforms. “We anticipate that the U.S. government will remain divided, preventing sweeping fiscal reforms by the new administration. As a result, fiscal policy proposals by both candidates will likely require intense bipartisan negotiations and compromise,” Moody’s said.

However, a scenario where one party sweeps both the presidency and Congress could open the door to more significant policy changes. Such a shift, however, also brings risks. The report warns that abrupt changes to key policies on taxation, trade, investment, immigration, and climate could introduce economic uncertainty, affecting the credit profile of public and private sector entities alike.

Moody’s Warning on Political Influence Over the Federal Reserve

One key area of concern highlighted by Moody’s is the potential influence of politics over monetary policy. Former President Donald Trump has repeatedly suggested that the Federal Reserve should be more responsive to the executive branch, breaking with the tradition of central bank independence. In August 2024, Trump stated that U.S. presidents should have more say in the decisions made by the Federal Reserve, a notion that Moody’s views as highly problematic.

Moody’s emphasized that political influence over the Federal Reserve would be “credit negative” for the U.S. financial system, as it could undermine investor confidence and potentially destabilize financial markets. The report noted, “Erosion of institutional strength can undermine confidence and impair the implementation of countercyclical policies, negatively affecting growth, financial markets, and the operating environment for debt issuers.”

Historically, the independence of the Federal Reserve has been a cornerstone of U.S. economic stability, helping to prevent short-term political interests from influencing long-term monetary policy. A break with this tradition could lead to uncertainty in financial markets, complicating efforts to manage inflation, interest rates, and overall economic growth.

The Debt Ceiling Crisis: A Lingering Issue

The U.S. debt ceiling has been a recurring source of political conflict in recent years. In 2023, the country narrowly avoided default after a prolonged standoff in Congress over raising the debt ceiling. This episode of political brinkmanship had severe consequences, as it led to Fitch downgrading the U.S.’s sovereign credit rating. Such conflicts not only damage the country’s fiscal reputation but also increase borrowing costs and create uncertainty in global financial markets.

The U.S. debt ceiling, a legal limit on the total amount of federal debt the government can accumulate, has been raised numerous times over the years to accommodate growing deficits. However, in recent years, it has become a political bargaining chip, with lawmakers using the threat of default as leverage in negotiations over fiscal policy. Moody’s report suggests that future administrations could face similar challenges, particularly if Congress remains divided.

In its report, Moody’s cautioned that continued political brinkmanship over the debt ceiling could have serious consequences for the U.S.’s credit profile. Failure to raise the debt ceiling in a timely manner could lead to default, triggering a financial crisis and further eroding investor confidence in U.S. Treasury bonds, which are widely regarded as one of the safest investments in the world.

Broader Implications for the U.S. Economy

The implications of a weakened fiscal profile extend beyond the U.S. government’s ability to manage its debt. A deteriorating fiscal outlook could have significant ripple effects throughout the economy. Higher interest rates, resulting from increased borrowing costs, could slow economic growth by making it more expensive for businesses and consumers to borrow money. At the same time, rising interest expenses would consume a larger share of the federal budget, leaving less room for spending on other critical areas, such as infrastructure, education, and healthcare.

Additionally, a weakened credit rating could reduce demand for U.S. Treasury bonds, which have long been considered a safe haven for investors worldwide. This could put upward pressure on interest rates, increasing borrowing costs for the U.S. government and potentially leading to higher taxes or cuts in government spending.

Moody’s report also highlights the importance of addressing long-term challenges, such as entitlement reform. Programs like Social Security and Medicare, which are essential to millions of Americans, represent a significant portion of the federal budget. As the U.S. population ages, these programs are expected to place increasing strain on the federal budget, further complicating efforts to reduce the deficit.

Conclusion

Moody’s warning about the U.S. fiscal outlook underscores the urgent need for policymakers to address the country’s growing debt burden. Whether Democrat Kamala Harris or Republican Donald Trump wins the 2024 presidential election, the next administration will face significant challenges in managing the nation’s finances. Political polarization, a divided Congress, and the growing costs of servicing the national debt will make it difficult to implement the necessary reforms.

If no meaningful policy steps are taken to curb deficits and reduce the debt burden, the U.S. could face further downgrades to its credit rating, which would have far-reaching consequences for the economy. The next administration will need to navigate these challenges carefully, balancing the need for fiscal responsibility with the demands of a divided political landscape.

photo source: Google

By: Montel Kamau

Serrari Financial Analyst

25th September 2024