Republicans are pushing for plans to massively cut US government spending The US has been warned that the credit rating on its government debt could be cut by Standard & Poor's. S&P is concerned that Democrats and Republicans will not be able to agree a plan to reduce the growing US deficit.
It has downgraded its outlook from stable to negative, increasing the likelihood that the rating could be cut within the next two years.
The US Treasury responded that S&P had underestimated its ability to tackle the national debt.
"Because the US has, relative to its 'AAA' [top-rated] peers, what we consider to be very large budget deficits and rising government indebtedness and the path to addressing these is not clear to us, we have revised our outlook on the long-term rating to negative from stable," the agency said in a statement.
The surprise move sent US and European shares lower. The S&P 500 fell the most in a month, and the US dollar dropped against the euro and Swiss franc. Oil was also sharply lower.
In Europe, the main UK, German and French indexes all fell by at least 2%.
The US federal deficit currently stands at $1.4tn (£858bn) and is expected to reach $1.5tn in the current fiscal year.
Budget battle
President Barack Obama suggested that the world could plunge into a new recession if the ceiling on money the US can borrow is not raised in the next few weeks, before the current debt limit of $14.3tn is reached.
Continue reading the main story Mr Obama and the Republicans are locked in a battle over the extent of spending cuts.The Republican-controlled House of Representatives has passed a 2012 budget plan that aims to cut $6.2tn in spending by the government over the next decade.
But the bill is not expected to make it through the Democrat-led Senate.
The current fight is over spending from 1 October onwards. Last week, Congress passed a budget bill that would cut $38.5bn in government spending over the rest of the current fiscal year, to 30 September.
Last week, Mr Obama laid out his plan to reduce the budget deficit by $4tn over 12 years.
'Political judgment'
Austan Goolsbee, the chief economist of the president's Economic Recovery Advisory Board, dismissed the change in outlook while making the rounds on US cable networks.
Ajay Rajadhyaksha, head of fixed income at Barclays Capital in New York assesses the US deficit dilemma"What the S&P is doing is making a political judgment and it is one that we don't agree with," he told CNBC.
The S&P outlook cut comes after the International Monetary Fund (IMF) warned last week that the size of the US deficit created instability in the financial markets.
In a statement, S&P was positive about the general state of the US economy, but said: "We believe there is a material risk that US 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 US fiscal profile meaningfully weaker than that of peer 'AAA' sovereigns."
'Wake-up call'
The US has the top AAA credit rating on its long-term bonds.
Since the US is the world's largest economy, and its debt is considered the backbone of the world's financial system, any concern over the US ability to pay its debt creates huge ripples in the world economy.
"It's a wake-up call that we need to do something," said Axel Merk, a currency fund manager in California. S&P is "absolutely correct that this is something serious that needs to be addressed."
But the US Treasury responded strongly to the change in outlook.
"We believe S&P's negative outlook underestimates the ability of America's leaders to come together to address the difficult fiscal challenges facing the nation," it said.
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