What the S&P Rating Announcement Means

With all the attention being given to the Standard & Poors (S&P) announcement on the U.S. debt, it's useful to read the release itself. S&P hasn't lowered its rating of U.S. debt, but has placed it on watch with a negative outlook, meaning that the AAA rating could be lowered in the future. This paragraph sums up the risk:

We believe there is a material risk that U.S. policymakers might not reach an agreement on how to address medium- and long-term budgetary challenges by 2013; if an agreement is not reached and meaningful implementation is not begun by then, this would in our view render the U.S. fiscal profile meaningfully weaker than that of peer 'AAA' sovereigns.

And this paragraph sums up what the federal government would need to do to restore the stable outlook:

Some compromise that achieves agreement on a comprehensive budgetary consolidation program--containing deficit-reduction measures in amounts near those recently proposed, and combined with meaningful steps toward implementation by 2013--is our baseline assumption and could lead us to revise the outlook back to stable. Alternatively, the lack of such an agreement or a significant further fiscal deterioration for any reason could lead us to lower the rating.

S&P was careful to point out that it doesn't have an opinion on how the deficit should be reduced. The rating agency's interest is in measuring the likelihood that the federal government will continue to make payments on its debt.