Fitch Warns of Possible Downgrade as We Approach the Fiscal Cliff

With time running out for a deal, the U.S. credit rating may be in jeopardy if lawmakers don't reach a compromise to replace the fiscal cliff. Fitch is the latest credit rating agency to warn that failure to come to an agreement would likely lead the U.S. to lose its AAA status. From Fitch's Global Sovereign Review (login required):

In Fitch's opinion, the tax increases and spending cuts implied by the fiscal cliff would not address the long-term drivers of higher public spending and the narrow and volatile tax base. Many of the measures would probably be partially reversed if the economy slowed and unemployment began to rise, perpetuating the uncertainty over government tax and spending policies that is weighing on the economic recovery. Failure to avoid the fiscal cliff would not, in Fitch's opinion, place US public finances on a long-term sustainable path. It would exacerbate rather than diminish the uncertainty over fiscal policy, and tip the US into an avoidable and unnecessary recession that could erode medium-term growth potential and financial stability. In such a scenario, there would be an increased likelihood that the US would lose its "AAA" status.

This statement from Fitch echoes comments made last week from Federal Reserve Chairman Ben Bernanke that both avoiding the cliff and having a sizeable deficit reduction plan are equally important. In terms of the latter, Fitch says that after a few years of kicking the can down the road, the U.S. needs to adopt a credible medium- to long-term fiscal consolidation plan.

The credibility of any deficit reduction plan would be greatly enhanced by specific measures and targets reflected in legislation with a significant down payment in 2013. Agreement on a multi-year deficit reduction plan to stabilise government indebtedness and secure the sustainability of public finances would be likely to lead to Fitch affirming the US "AAA" rating and revising the Rating Outlook to Stable. Conversely and in the absence of positive economic and fiscal shocks, failure to put in place a credible fiscal consolidation strategy during 2013 would be likely to result in the US losing its "AAA" status.

Fitch is not the only agency with a current "Negative" outlook on the U.S. Here is a reminder of where the other credit agencies stand:

U.S. Credit Rating By Agency
Rating Agency Grade Outlook
Standard & Poor's AA+ Negative
Moody's Aaa Negative
Fitch AAA Negative
Egan-Jones AA- Negative
Japan Credit Rating Agency  AAA  Stable
Rating and Investment Information  AAA  Stable

Source: Agency Outlooks

Hopefully, the White House and Republican leaders will take the final steps toward a deal over the next few days. While decent progress has been made in recent weeks, there is still a long ways to go.