Tim Mullaney, USA TODAY
Fitch Ratings took a step toward cutting the U.S. government's AAA debt rating Tuesday, as the clock ticked toward the Thursday deadline to raise the nation's debt ceiling or risk default.
Chicago-based Fitch, the third-largest of the major debt-rating companies behind Standard & Poor's and Moody's Investors Service, put U.S. Treasury bonds on Rating Watch Negative, which is sometimes but not always a first step before a downgrade. Fitch said in a statement that it still thinks the debt ceiling will be raised in time to prevent a default.
Fitch said the government would have only limited capacity to make payments on the $16.7 trillion national debt after Treasury Department's emergency measures run out Thursday.
Some Republicans have advocated Treasury make debt service payments before paying day-to-day bills, but Fitch said that may not be legal or technologically possible. Even Treasury could do that, a failure to act would still leave the U.S. missing payments for Social Security and payments to government contractors, Fitch said.
"All of (these) would damage the perception of U.S. sovereign creditworthiness and the economy,'' Fitch said in a statement. "The prolonged negotiations over raising the debt ceiling ... risks undermining confidence in the role of the U.S. dollar as the preeminent global reserve currency, by casting doubt over the full faith and credit of the U.S. This `faith' is a key reason why the U.S. 'AAA' rating can tolerate a substantially higher level of public debt than other AAA" bonds.
Fitch said it could make a decision on whether to lower its AAA rating on U.S. debt by the end of the first quarter.
"The announcement reflects the urgency with which Congress should act to remove the threat of default hanging over the economy," the Treasury Department said in response.
One money manager quickly backed Fitch's action, which affects all U.S. bonds.
"This action by Fitch is not about ability to pay,'' said Cumberland Advisors chief investment officer David Kotok. "It is about governance and our willingness to pay. In that category the United States has reached the brink of political failure.''
Economists have warned that there are two main ways failing to raise the debt ceiling could hurt the economy.
One is by causing chaos in financial markets, forcing stock prices lower and freezing credit to many borrowers. The other is by forcing the government to cut spending by as much as $130 billion over as little as six weeks to avoid borrowing more, Moody's Analytics estimated last week.
A study Tuesday by Bard College estimated that a rapid-fire balanced budget scenario would cause the U.S. economy to shrink by almost 3% in 2014 and the unemployment rate to surge to more than 9.5%.
That is before accounting for the chance that a failure to raise the debt ceiling will push U.S. trading partners into recession, the Bard study says.
"A recession in the United States would certainly exert a negative influence on growth in the rest of the world, which would in turn feed back to the States," Bard economist Michalis Nikiforos said.
Moody's says it has no plans to change its Aaa rating on U.S. debt.
Political brinksmanship was a key reason for S&P's downgrade of the U.S. to AA+ from AAA in 2011, the last time Washington flirted with refusing to raise the debt ceiling. The lack of an agreement on the debt limit this week would not necessarily trigger another S&P downgrade, spokesman John Piecuch said.
"Passing (Oct.) 17th is not a specific trigger," Piecuch said.
If the U.S. missed a debt payment, however, its rating would be lowered to selective default, he added.
Contributing: John Waggoner, Adam Shell and David M. Jackson