The downgrade of the US’s sovereign credit rating by Fitch sent global stock markets lower, interrupting a steady climb and stirring volatility for the first time in months.
The general consensus among strategists and fund managers has been that the rating cut should have a limited impact on equities, with Wells Fargo & Co. saying any pullback will be “short and shallow” and Liberum Capital describing the news as a “tempest in a teapot.” US Treasuries and the dollar didn’t budge on the news.
For some, it’s a good excuse to book some profits after a 19% jump this year in the S&P 500. Futures on the benchmark fell 0.7% at 6:10 a.m. in New York. The index hasn’t had a down day of 1% or more in 47 straight sessions, the longest such streak of calm days since January 2020.
Here’s what analysts and strategists had to say:
Alexandre Baradez, chief market analyst at IG in Paris
“One can have the feeling that the market is looking for excuses to take some profits. But rather than the Fitch downgrade, I suspect that what’s currently being priced is the growing risk of an economic slowdown. The downward trend started to emerge yesterday on the back of disappointing Chinese and US data, which suggests it’s not really about the rating downgrade but rather the risk of a slowdown.”
Chris Harvey, head of equity strategy at Wells Fargo & Co.
“Fitch’s downgrade should not have a similar impact to S&P’s 2011 downgrade given the starkly different macro environments and other reasons. Heading into S&P’s Aug 2011 downgrade, markets were in “risk-off” mode, with equities in a correction, credit spreads widening significantly, rates falling, and the GFC was still in the market’s collective conscience. Today, we have almost the opposite: IG credit spreads hit a YTD low of 112bps at month end, interest rates have been floating up, the SPX has returned 20% YTD, and many investors expect the Fed to cut rates by early 2024. As a result we believe any equity market pullback would be relatively short and shallow.”
Manish Kabra, head of US equity strategy at Societe Generale SA:
“The market will initially look at the 2011 playbook when we had a kneejerk, major risk-off reaction. But what’s different this time is the nominal growth outlook which is much higher than 2011, so I expect any profit taking to be short-lived. More broadly, if US bond yields can come down, that would be the signal that we’re getting closer to the end of the major risk-off signal. Before majority of institutional investors come out and buy equities, they would like to see the yield curve go positive. We would like to see that happen too before upgrading equities to a material overweight.”
Mark Dowding, chief investment officer at RBC BlueBay Asset Management LLP
“On the whole, we don’t see the Fitch downgrade to US as particularly significant. However, it serves as a reminder that there will be heavy ongoing issuance of Treasuries on a forward-looking basis and this is something that can weigh on global markets if this prompts a steepening of the yield curve and a rise in the discount rate for longer-dated cashflows. I would also note that over the past few weeks, investors have been buying into the Goldilocks theme in the US economy, causing entrenched bears to capitulate. However, inasmuch as the market starts to price for perfection, then it will become intrinsically more vulnerable to a correction.”
Raphael Thuin, head of capital markets strategies at Tikehau Capital
“Today’s market price reaction shows how markets are getting uncomfortable with the long-term sustainability of rising government debt. There’s absolutely nothing new in what Fitch had to say but it puts the finger, in a moment where markets are somewhat febrile, on the issue of over-leveraging in a world of lower economic growth and higher yields. On the mid-term we will enter a cycle of deleveraging and that will progressively add some risk to the market.”
Richard Saldanha, a global equity fund manager at Aviva Investors
“Whilst the Fitch US downgrade is notable, we don’t think this will have a significant impact from an investment perspective – investors are much more focused right now on inflation (where we are seeing a gradual easing based on recent data) as well as confirmatory signals from the Fed that we are now near the peak of the hiking cycle. With signs that we may be getting closer to a soft landing scenario rather than an outright recession, as well as a fairly upbeat earnings season thus far, we think there are reasons to believe markets can sustain their recent gains.”
Joachim Klement, head of strategy, accounting and sustainability at Liberum Capital
“We think the downgrade of the US credit rating will not have a material impact on equity markets, US Treasuries or the US dollar. While the downgrade came at a surprising moment, it is not unjustified given the large deficit of the US government and the lack of projected deficit reduction in the coming three to five years. But there is no reason to sell US Treasuries or demand an increased risk premium, in our view, since there is no alternative to Treasuries in global bond markets, nor is there any material default risk in the coming decade, in our view. All in all this is a tempest in a teapot.”
Amy Xie Patrick, head of income strategies at Pendal Group
A credible alternative in terms of safe and large enough markets would be required if investors were to sell Treasuries, she said. “What would that be at the minute? Euro govvies? That’s still a currency breakup accident waiting to happen because of lack of fiscal unity. China? Nobody wants that sovereign risk. Japan? BOJ still owns half the market. It would take a lot for people to start taking these downgrades seriously and stop flying to quality with Treasuries. These sovereign downgrade events pertaining to high-quality developed-market sovereign ratings are a bit like these debt-ceiling debacles — can cause a bit of short term angst, but never amounts to anything much.”
Galvin Chia, emerging market strategist at NatWest Markets
“From an investment standpoint, I don’t think there’s a case to hold less Treasuries in the portfolio, ie as a result of higher political risk. In the broad scheme of things, things like the sanction of Russian financial markets after the Ukraine invasion and questions of de-dollarization (ie. reintroducing politics and political risk into finance) will be raising more questions about the role of US assets in financial markets, rather than the ratings per se.”
James Wilson, senior portfolio manager at Jamieson Coote Bonds
“We do not believe the Fitch downgrade will have a huge market impact, as this brings the US into line with S&P ratings which were downgraded in 2011. The financial system has weathered much bigger storms since then, and the bigger factor towards higher yields is the glut of Treasury supply that is set to come through the market with the larger coupon announcement. 10-year USTs have popped up above 4% which has been a line in the sand for investors over the last year. I would expect this demand to continue.”
Alec Phillips, an economist at Goldman Sachs
“The downgrade mainly reflects governance and medium-term fiscal challenges, but does not reflect new fiscal information. The downgrade should have little direct impact on financial markets as it is unlikely there are major holders of Treasury securities who would be forced to sell based on the ratings change.”
Alvin Tan, head of Asia FX strategy at RBC Capital Markets
“US Treasuries are the world’s largest and most liquid sovereign bond market. It’s unthinkable large global bond investors will decide to entirely exclude US Treasuries from their holdings. If they do, what USD-denominated bonds will they hold? Some investors may have to cut, especially the non-US domiciled funds. But I would not be surprised if many of them decided that they needed to change their mandates too in order to keep on holding US Treasuries”
David Croy, interest rate strategist at Australia & New Zealand Banking Group
“I suspect the market will be in two minds about it - at face value, it’s a black mark against the US’s reputation and standing, but equally, if it fuels market nervousness and a risk-off move, it could easily see safe haven buying of US Treasuries and the USD. It’s finely balanced.”
Laura Fitzsimmons, executive director of macro rates & FX sales at JPMorgan
“The 2011 experience saw the flight to quality for USD and USTs in that environment, contrary to what would normally occur on a sovereign downgrade given the US’s key global position. Hence less of an obvious trade for FX players here, but we will watch to see if any more negative reaction in USTs which would provoke interest”
Carol Kong, a currency strategist at Commonwealth Bank of Australia
“The USD may ease further in coming sessions if markets consider the rating cut will undermine the USD’s reserve currency status and markets sell their US Treasury bond holdings. But I don’t expect the USD will sustain any losses. Credit ratings are not typically a major medium term driver of currencies.”
Andrew Ticehurst, a rate strategist at Nomura
“USD could underperform some of the majors, like EUR and JPY. Higher-beta currencies across Asia should fare less well of course if this news leads to some broad risk-off price action. Ironically, if this headline causes some risk-off price action across asset classes, money will likely flow to defensive assets, and that includes highly liquid US Treasuries.”
--With assistance from Michael G. Wilson, Chester Yung, Wenjin Lv, Iris Ouyang, Matthew Burgess, Ruth Carson and Farah Elbahrawy.
