By Daniel Bases
NEW YORK (Reuters) - Fitch Ratings warned on Tuesday it could cut the sovereign credit rating of the United States from AAA, citing the political brinkmanship over raising the federal debt ceiling.
"Although Fitch continues to believe that the debt ceiling will be raised soon, the political brinkmanship and reduced financing flexibility could increase the risk of a U.S. default," the firm said in a statement.
The firm put its opinion about the creditworthiness of U.S. government debt on what its calls Ratings Watch Negative, a reflection of the increasing risk of a near-term default if the debt limit is not raised in time. It gave itself until the end of the first quarter of 2014 to decide whether it will actually cut the rating.
Still, Fitch reaffirmed its belief that an agreement to raise the debt ceiling will be reached, allowing the U.S. government to pay its bills by borrowing beyond the $16.7 trillion limit currently in place.
Fitch is the only one of the three major credit rating agencies to have a negative outlook on the U.S. sovereign credit. Standard & Poor's downgraded the rating to AA-plus with a stable outlook during the last debt ceiling impasse, in August 2011.
"It seems like what we saw from S&P just before the downgrade, they were essentially warning us that the debt ceiling standoff will not be tolerated and this is not in line with a country that maintains an AAA credit rating. It's citing these artificial default risks as the main reason ... They are essentially saying get this done now," said Gennadiy Goldberg, interest rate strategist at TD Securities in New York
Fitch reiterated that the delay in increasing the borrowing capacity of the United States raises questions about the ability of the United States to honor its obligations.
Moody's Investors Service rates U.S. government debt at Aaa with a stable outlook.
The U.S. Treasury has said that on or about October 17 the government will reach its borrowing limit, thereby putting at risk its ability to pay its bills.
Fitch is operating under the assumption that even if the debt limit is not raised before or shortly after Oct 17, there will be sufficient political will and capacity to ensure the United States will honor its debts.
A Treasury spokesman said Fitch's decision is a reminder for U.S. lawmakers that the United States is dangerously close to defaulting on its obligations.
Negotiations between President Barack Obama and congressional leaders cycled through a stop-start process again on Tuesday, but no agreement was reached to reopen the government and raise the debt ceiling.
Last week Fitch said that it would only consider the United States in default if it failed to make payments due on interest or principal of U.S. Treasuries.
"It lets investors know that this kind of risk is on the horizon. We'll see what happens. I was hopeful earlier today that sides were moving to an agreement, but now, I don't know," said John Carey, portfolio manager at Pioneer Investment Management in Boston.
The warning came after the U.S. stock market closed for the day, after a volatile trading session in which benchmark U.S. equity indexes fell amid the political uncertainty.
In late New York trade, the U.S. dollar dropped to session lows against the yen and trimmed earlier gains against the euro.
"This is not the way the dollar behaved during the Lehman crisis or during the debt downgrade by the S&P in August 2011. So we think yes, the more the U.S. credit rating is called into question, the worse it will be for the U.S. dollar," said Michael Woolfolk, senior currency strategist at BNY Mellon in New York.
U.S. Treasury prices, already weak ahead of Fitch's announcement, held their losses on the day.
"The United States has the absolute capacity to pay its debt. This action is not about ability to pay. It is about governance and willingness to pay. In that category the United States has reached the brink of political failure," said David Kotok, chairman and chief investment officer at Cumberland Advisors in Sarasota, Florida.
(Additional reporting by Caryn Trokie, Karen Brettel, Ryan Vlastelica, Luciana Lopez, and Wanfeng Zhou in New York; Jason Lange in Washington)