US warned over budget chaos as big cuts loom

The US was warned Wednesday that its chaotic budget politics could lead to a new credit downgrade as the country readied for the impact of steep automatic spending cuts that begin in two days.

Fitch Ratings said Washington could lose its top-flight AAA credit rating not because of the implementation of the $85 billion in austere "sequester" cuts, but because the deficit policy battles are undermining confidence in the government.

It pointed to the next fight, over a new six-month spending plan that, if not agreed by the end of March by warring Democrats and Republicans could force a shutdown of the government in April.

"Implementation of the automatic spending cuts -- the sequester -- and a government shutdown would not prompt a negative rating action," Fitch said in a statement.

"But such an outcome would further erode confidence that timely agreement will be reached on additional deficit-reduction measures necessary to secure the 'AAA' rating."

Politicians and markets were resigned to the sequester cuts that begin from March 1, forcing heavy pullbacks in government spending on defense and other areas.

Economists, including Federal Reserve chief Ben Bernanke, say the sequester could trim another 0.5 percentage point or more from economic growth this year.

The White House has warned of a "perfect storm" of widespread employee furloughs, nationwide airport delays and less secure US borders, and says pre-school programs could be canceled, teachers laid off and public services curtailed.

Alice Rivlin, a Brookings Institution economist and formerly a top government budget expert, said the sequester cuts will "endanger the economic recovery that is finally picking up speed."

"More austerity will stall job growth, as similar policies have in Europe."

Investors seemed unfazed as US stocks gained for a second straight day Wednesday.

But analysts said that the budget impasse had contributed to the key indices being stuck in neutral for the past five weeks, after the S&P 500 and the Dow Jones Industrial Average had come close to beating all-time highs.

"It does look like that sequestration is going to happen," said David Levy, a portfolio manager at Kenjol Capital management.

"Investors may be taking some gains ahead of the uncertainty, stepping aside, but they don't sell the market on the uncertainty of sequestration."

Investors are only moderately concerned, said Hugh Johnson of Hugh Johnson Advisors.

"Investors do not believe that it will lead to a recession, and that wasn't true for the fiscal cliff," he said, referring to the earlier massive cuts and tax hikes package that was to come into play on January 1 before a political deal modified them.

There was still a possibility that the sequester cuts could be avoided or softened.

Congressional sources said Wednesday that President Barack Obama will hold talks with congressional leaders Friday at the White House, including Republican Representative John Boehner and Senator Mitch McConnell, and Democratic Senator Harry Reid and Representative Nancy Pelosi.

A deal on more moderate spending pullbacks within the first weeks of March could mitigate most of the sequester's impact as government furloughs and other cutbacks will only be really felt beginning in April.

But it appeared that the sequester talks were being commingled with budget extension talks, with the same issues at the center: Republican demands for spending cuts against Democrats' insistence on revenue increases as well.

The two sides have to come up with another six-month "continuing resolution" by March 27 to keep the entire government funded.

Past that, the Congress and White House have another deadline, May 19, to raise the US borrowing ceiling or face, for the third time in two years, the possibility of defaulting on its debt.

Fitch said it does not expect a repeat of the debt ceiling crisis of August 2011, which prompted Standard & Poor's to strip the United States of its AAA rating.

But Fitch said that failure this year to raise the ceiling "in a timely fashion" would "likely" lead it to downgrade the US as well.