Moody's is the first of the big-three credit rating agencies to place the United States' Aaa rating on review for a possible downgrade, meaning the agency is close to cutting the country's rating.
Standard & Poor's placed the U.S. rating on negative outlook on April 18 which meant a downgrade is likely in 12-18 months.
"They are worried they are having these ideological arguments while Rome burns," saidCarl Kaufman, portfolio manager at Oster weis Capital Management in San Francisco.
A lower credit rating would cause havoc in financial markets around the world and increase borrowing costs for the government and businesses, further harming public finances and weighing on the economic recovery.
In a statement, Moody's said it sees a "rising possibility that the statutory debt limit will not be raised on a timely basis, leading to a default on U.S. Treasury debt obligations."
Risks of a default on Treasuries, traditionally seen as the world's safest investment, have increased since the government reached its legal borrowing limit of $14.294 trillion on May 16.
Congress has refused to raise the statutory borrowing limit until agreement is reached on cutting the fiscal deficit which was $1.29 trillion in the last fiscal year.
The Treasury Department has said if the debt ceiling is not raised by August 2 it will have to start prioritizing payments.
DEFAULT RISK NO LONGER "DE MINIMIS"
Moody's said the probability there will be a default on interest payments is low, but it is "no longer to be de minimis."
"If the debt limit is raised again and a default avoided, the Aaa rating would likely be confirmed," Moody's said.
"However, the outlook assigned at that time to the government bond rating would very likely be changed to negative at the conclusion of the review unless substantial and credible agreement is achieved on a budget that includes long-term deficit reduction," the firm said.
There is precedent for Moody's decision. In 1996 the firm put some issues of U.S. Treasury debt on watch for a downgrade when the White House and Congress failed to extend the government's debt ceiling.
Moody's decision came after U.S. markets had closed on Wednesday but before Asian markets ramped up their activity. In the 24-hour currency markets the U.S. dollarindex, which measures the greenback against a basket of trading partner currencies, had fallen earlier in the session and ended down 1.1 percent, marking the steepest one-day decline since early December.
"In the short-term, the dollar definitely has its problems. This ratings news sent the dollar tumbling. This is really not good," said Brian Dolan, chief strategist at Forex.comof Bedminster, New Jersey.
"Moody's might be doing this based on the politics as much as the threat of default, because the politics have become so problematic.... Between this and (Ben) Bernanke talking about QE3, the dollar could be entering a new downward phase," he said.
The U.S. dollar fell on Wednesday after Federal Reserve Chairman Ben Bernanke said the central bank could inject more monetary stimulus into the U.S. economy.
The currency fell to a record low against the Swiss franc. The greenback hit a trough of 0.8095 franc, on electronic trading platform EBS.
In after-hours trade, U.S. stock futures dropped 4.8 points to 1307.20 following Moody's decision.
COLLATERAL IMPACT
In addition, the credit ratings for institutions directly linked to the U.S. government were also put on review for a possible downgrade, including Fannie Mae, Freddie Mac, the Federal Home Loan banks and the Federal Farm Credit banks.
The ramifications of a U.S. downgrade could also be felt in places such as Israel andEgypt.
Moody's says the specific bonds issued by these two governments which carry a U.S. government guarantee "were also placed on review for possible downgrade." Israel and Egypt issue bonds without Washington's guarantee, and presumably they would not be subject to the current situation.
The Congress has routinely raised the nation's debt limit in the past. This time, however, negotiations seem to have stalled over the degree to which the fiscal deficit should be cut by raising taxes or cutting spending.
So far, Treasury Secretary Timothy Geithner has been able to resort to extraordinary measures to delay a debt default by at least August 2.
Unlike Fitch, which promised to cut the U.S. ratings to "restricted default" after a few missed debt payments, Moody's has said it would downgrade the United States to the "Aa" range, still considered investment grade.
(Reporting by Walter Brandimarte and Daniel Bases; Editing by Leslie Adler and Clive McKeef)
