UPDATE: S&P Affirms US Rating at AA+; Outlook Stable

OVERVIEW -- Credit strengths of the U.S. include its diversified and resilient economy, its extensive economic policy flexibility, and its unique status as the issuer of the world's leading reserve currency. -- However, a polarized policymaking environment and high general government debt and budget deficits constrain the ratings. Although the debt burden has stabilized, it will likely rise toward the end of the decade absent medium-term measures to raise additional revenue and/or to cut nondiscretionary expenditure. -- We are affirming our 'AA+/A-1+' sovereign credit ratings on the U.S. -- The outlook remains stable, reflecting our view that there is less than a one-in-three chance that we will change the rating in the next two years based on our expectation that the inherent economic and policy strengths of the U.S. will continue to be juxtaposed against an absence of political cohesion for bolder medium-term policy measures. RATING ACTION On June 6, 2014, Standard & Poor's Ratings Services affirmed its 'AA+' long-term and 'A-1+' short-term unsolicited sovereign credit ratings on the United States of America. The outlook on the long-term rating remains stable. RATIONALE The sovereign credit ratings on the U.S. are supported by the resiliency and diversity of its economy, its institutional strengths, its extensive economic policy flexibility (including its management through the 2008-2009 global financial crisis, particularly its innovative monetary policy), and its unique status as the issuer of the world's leading reserve currency. A higher degree of political brinksmanship in recent years--that complicates the policy decision-making process, resulting in a somewhat weaker ability to enact reform--constrains the ratings. The general government debt burden has doubled since 2007. Although it is projected to hold steady over the next several years, we, along with many other observers, expect the general government debt burden to rise toward the end of the decade absent measures to raise additional revenue and/or cut nondiscretionary expenditure. With a per capita GDP of US$54,750 for 2014, the U.S. ranks 14th out of the 129 sovereigns that Standard & Poor's rates in terms of income level. The breadth and depth of the U.S. economy, coupled with a track record of proactive policymaking at the depth of the recession, underpin the recovery since that time. The level of real GDP is 11% higher than its nadir in second-quarter 2009. Although the recovery has been subpar compared with previous rebounds, it has occurred from the deepest economic downturn since 1929. The pace of the U.S. rebound also compares favorably with those of its advanced economy peers. Long-term potential growth, however, has declined, in our view. It is likely to be closer to 2% rather than 2.5%, reflecting aging demographics (which contribute to labor force participation being at a 36-year low) and diminished labor productivity gains over the past decade compared with the postwar average. However, over the next several years, we expect real GDP growth of 2.5%-3.5%. This growth rate is supported by a revival in manufacturing due to competitive labor costs and the lower cost of natural gas stemming from increased shale gas production. In addition, deleveraging in the U.S.'s household sector is more advanced than it is for European peers, and the U.S. banking system has bolstered its financial strength more through raising capital than deleveraging. Compared with prior years, we expect less fiscal drag at the federal, state, and local government levels (together, the general government) in the near term. As economic and labor market conditions have improved, the Federal Reserve has begun a slow process of normalizing monetary policy. Long-term unemployment, while down, remains high, at more than twice that of prerecession levels, and with its concentration in the young and the old, poses a policy concern. The U.S.'s policymaking and political institutions tend to be transparent and accountable. The checks and balances of the U.S.'s system of government have generally generated a stable backdrop for economic prosperity and the free flow of information, notwithstanding the recent budgetary debates. Unparalleled economic data in terms of timeliness and coverage are readily publicly available. A strong civic society, political stability, respect for property rights and the rule of law, and success as a driver of innovation have supported economic prosperity and underpin the U.S. dollar's status as the world's premier reserve currency. This reserve currency status affords the U.S. significant flexibility in its external accounts. Taking into account the key reserve currency status, as well as the degree to which the U.S. has supplied liquidity around the globe in recent years, our political and economic analysis suggests that the U.S. has unparalleled external liquidity. The external analysis is complicated by the dominant reserve currency role. Whereas the ratio of external debt, net of liquid assets, averaging about 360% of current account receipts (CAR) during 2014-2017, is high compared with the ratios of most sovereigns, the overall net external liability position of the U.S., at 195% of CAR over this same period, is much lower. In addition, the debtor position may be overstated, considering currency issues, composition considerations, and the difficulty of recording multinational activity of U.S. private companies in offshore centers. Valuation effects on the U.S.'s external assets and liabilities, including derivatives, dominate the external stocks vis-a-vis the balance of payments cash flows. The current account deficit declined to 2.3% of GDP as of 2013 from a prerecession 2006 peak of 5.8% of GDP, and we expect it to remain around this level. Prospects for ongoing shale gas and oil production could turn the U.S. from a net energy importer to potentially a net energy exporter. In October 2013, domestic production of crude oil was higher than imports for the first time since 1995. The significant increase in natural gas production--with the U.S. the largest natural gas producer in the world--will support natural gas exports. At the outset of the 2008-2009 recession, the Federal Reserve Bank acted promptly and innovatively to staunch the collapse in credit. It provided exceptional support to broker-dealers, commercial paper issuers, mutual funds, large insurance companies, U.S. offices of foreign banks, and foreign central banks, to name a few. These operations have since been wound down. At the same time, the Fed has supported monetary conditions through balance sheet expansion, having reached the zero bound in interest rates in 2008. The Fed's holdings of government securities and mortgage-backed securities rose to $4.1 trillion (24% of GDP) at the end of May 2014 from $741 billion in December 2007 (5% of GDP). In our view, the Fed will likely begin to rein in its balance sheet only after the first hike in the federal funds rate (which could be in the second quarter of 2015). In preparation for this normalization, the Fed has developed its tools to manage the process, including paying interest on bank reserves and expanding the list of eligible counterparties for reverse repurchase transactions. We believe inflation expectations are well-anchored, as evidenced by the yields on 10-year TIPS (government inflation-linked notes). The stability and predictability of U.S. policymaking and political institutions, while high, have weakened in recent years, in our view. We find that the political impasses have impeded more effective policymaking compared with some of the U.S.'s other peers. This is underscored most recently by the simultaneous acrimonious debates in October 2013 about raising the debt ceiling and shutting down the government. As we expected, a last-minute compromise was struck, but we find the repeated shorter-term nature of political fiscal calculations and deal-making to be negative credit factors. That said, some agreements have been struck. Both parties reached across the aisle to conclude The Bipartisan Budget Agreement (BBA2013) in December 2013. BBA2013 provided partial relief from the automatic sequestration of discretionary spending in fiscal 2014 and fiscal 2015 (by a combination of higher revenues, spending reductions, and extending sequestration beyond its previous end date by an additional two years); the agreement on overall discretionary spending levels should facilitate funding appropriation through fiscal year-end Sept. 30, 2015. The same was done to avoid the so-called "fiscal cliff" in December 2012 as both parties passed the American Taxpayer Relief Act (ATRA2012), making permanent some expiring tax cuts and allowing high-income tax cuts to expire. However, more ambitious steps to stem rising medium-term fiscal pressures do not appear to be in the offing. Although both parties agree on the need to lower the government debt burden, the discussions about how this might be achieved are acrimonious. In the near term, including the run-up to the presidential elections in 2016, we do not expect entitlement or tax reform to advance. We believe that renewed debate over the debt ceiling could resume after the midterm elections in November 2014 under certain scenarios. While we expect the discussions about the debt ceiling to be ultimately resolved as they have been, we still see risks that these debates entail. Against this backdrop, we see that the fiscal position of the U.S. has, in fact, improved from 2009 on a flow basis, namely a decline in government deficits. The improvement is part cyclical and part structural following from policy decisions: namely implementation of the Budget Control Act of 2011 (BCA2011), ATRA2012, and BBA2013.