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New Power Brokers Enter the Debt Ceiling Fight

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Ratings agencies will be thrust into the spotlight in a bitter fight over the nation's finances, now that the so-called fiscal cliff has been averted and lawmakers have agreed to a temporary suspension of a "debt ceiling," which, at worst, could have put the US government at risk of default.

Now, with months left before a debt ceiling returns as a risk for the government, all eyes will be on whether Democrats and Republicans can agree to a budget in the absence of bargaining chips such as cliffs and ceilings.

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But if the opinions of lawmakers, notably Congressional Republicans, have lost some influence to investors in the debate over the nation's finances and budget deficit, those of ratings agencies have been strengthened.

Debate in Washington may no longer resemble a hostage negotiation. However, rating agencies on Wall Street may now hold all parties, including President Obama, captive to an eventual budget deal that reins in government deficits and debt. A downgrade of the government's debt rating may be the new poker chip that drives federal budget talks.

For instance, Fitch said on Monday it won't have to review the US government's AAA rating given the debt ceiling suspension, but it also stressed that a downgrade could come in 2013 and reiterated a "negative" outlook on the nation's credit rating. What's key, it appears, is that Washington will now have to hammer out a budget in a business-as-usual manner instead of the brinksmanship that's driven fiscal policy in recent years.

"Without the distraction of a near-term funding crisis for the federal government, Congress and the administration have the space to focus on the substantive fiscal policy choices necessary to place public finances on a sustainable path over the medium to long term," David Riley, a managing director at Fitch Ratings, said in a ratings note Monday.

If lawmakers agree to a credible medium-term deficit-reduction plan, Fitch said it would remove its "negative" rating. No deal, or one that falls short of changing the government's debt-to-GDP trajectory, would lead to a downgrade by year-end, the agency said.

Fitch isn't alone.

As the fiscal cliff debate raged, Moody's said in September it may downgrade the US debt rating from Aaa -- its highest rating -- to Aa1 by 2014 if budget negotiations during the 2013 Congressional legislative session fail to stabilize the federal debt-to-GDP ratio.

Currently, Moody's holds the US government's Aaa rating with a "negative" outlook, signaling that a rating review would likely yield a cut.

S&P already reduced the country's AAA rating in the summer of 2011 when the first debt ceiling standoff nearly prompted a US government default.

Although a debt ceiling suspension cedes a powerful bargaining chip in budget negotiations, Washington power brokers still hold plenty of leverage.

"Avoiding a government 'shutdown' requires Congress to pass a continuing resolution by March 27 and the deferred spending sequester comes into effect on March 1," Fitch Ratings noted.

While failure to meet those deadlines wouldn't prompt a downgrade, it might indicate that "it would undermine confidence in the prospects for reaching agreement this year on a credible deficit-reduction plan necessary to forestall a downgrade of the US rating," the agency said.

An imminent downgrade of the government's AAA rating is off the table in the wake of a three-month suspension of the debt ceiling agreed on Friday, Fitch said.

The move pushes back the prospect of a destabilizing debt downgrade and may be cause for some investor cheer as the S&P 500 (INDEXSP:.INX) and Dow Jones Industrial Average (INDEXDJX:.DJI) open the year with a rally.

Still, Fitch Ratings, Moody's and S&P could spoil the party in 2013 if Congress and the Obama administration can't broker a budget deal in the coming months.

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