Debt-ceiling deal might not prevent a downgrade in the nation's credit rating

The debt deal negotiated by the White House and congressional leaders is unlikely to drag down the economy but might not prevent a downgrading of the U.S.’s triple-A credit rating, a range of economists and financial analysts said Monday. 

Markets on Monday soared at the news of the deal before immediately tumbling after a weak report on the manufacturing sector. 

The sudden swing highlighted the fact that even as the debt talks have dominated Washington, investors have had their attention on a number of other economic data that reflect the struggling economy. 

The Dow Jones Industrial Average closed the day down 10.75 points, or 0.09 percent.

Views of the package alternated between those hailing it as ending uncertainty over whether the debt ceiling would be raised and those criticizing it for freezing spending while the economy cools. 

“Markets will definitely take this as a positive,” Gus Faucher, director of macroeconomics for Moody’s Analytics, said of the deal. “It reduces a lot of the uncertainty that’s out there … people will feel more confident about the economy.”

Stan Collender, an expert on public communications and the congressional budget process at Qorvis Communications, said the deal would hurt the economy in the near term by cutting off federal spending.

“Short-term, it’s absolutely, positively, no doubt about it, no dispute at all, going to be a negative for the economy,” said Collender. “If now the federal government cuts back at the same time and there’s no offsetting increase in the private sector, where’s the stimulus coming from?”

Several economists, however, noted that most of the spending cuts in the package occur several years down the road, which could minimize any adverse impact. 

“The way the deal is structured, mostly big cuts are back-loaded,” said Drew Matus, senior economist for UBS. “For 2011, it will do nothing, at least directly.”

“Deficit reduction is good for the economy in the long run, but it can entail short-run drag,” said Joel Prakken, chairman of Macroeconomic Advisers. If the deal is “as back-loaded as the initial reports suggest,” Prakken said, there will be less of a drag than initially expected. 

Following two disappointing jobs reports that showed the unemployment rate climbing, the government reported Friday that the nation’s gross domestic product grew a paltry 1.3 percent in the second quarter of the year — well below the 3 percent growth economists believe is needed to create enough jobs to meet an increasing population. Even more disappointing was the revision for the first quarter, which pegged growth at a minuscule 0.4 percent.

“Recent GDP growth has slowed to a rate that has, in the past, always been associated with a recession,” Prakken said. 

Another concern voiced about the deal on Monday is that it might be too small to win over the credit rating agencies, which all have aired concerns that a downgrade of the nation’s rating could be in the works if its debt problems are not addressed.

“It all hedges on whether Moody’s [Investors Service] and S&P were serious about their threat of downgrade, because there’s no way this plan meets their expectations,” said Veronique de Rugy, a senior research fellow at the conservative Mercatus Center at George Mason University.

So far, the rating agencies have been mum on the new deal while officials there continue to review the package to determine if it does enough to salvage the AAA rating.

Last week, financial markets responded to the debt-limit drama with a steady sell-off as more and more investors sought safe havens while Washington duked it out. The Dow shed 4.2 percent last week, the worst week of trading in a year.

After the deal was announced Sunday evening, investor optimism was immediately apparent — when markets opened Monday, all major stock indexes promptly spiked, while the price of safe investor havens like gold fell.

But it is clear that investor confidence in the economic recovery remains fragile. Less than an hour into the day’s trading, a disappointing economic report on the decline of American manufacturing immediately erased all gains the stock market had made on the news of a debt-limit deal. Markets finished down at the end of Monday for the sixth day in a row.

Some questioned Monday whether the protracted fight among policymakers over the artificial threat that government would not raise the debt ceiling had damaged confidence in the United States’ ability to tackle issues.

“It does raise some concerns about … the ability of policymakers to respond to economic conditions,” Faucher said. “There are real economic effects from what should really be an irrelevant policy decision.”