Fitch's recent decision to lower the United States' sovereign credit rating has gained widespread attention.
Following Fitch's move, Wall Street Journal noted that Moody's, another international credit rating agency, has not taken any action on the U.S.' credit rating. This week, the only adjustment made by Moody's to sovereign credit ratings of any country was downgrading Nigeria's rating to Caa2 and putting it under negative observation. Moody's remains the only one of the three major international rating agencies to have not downgraded the U.S.' rating.
As previously mentioned by the Wall Street Journal, compared to the market "quake" triggered by Standard & Poor's (S&P) downgrading of U.S.' credit rating in 2011, the market's reaction this time was much calmer. However, the "major landmine" hidden in U.S. debt has once again caught Wall Street's attention.
Former U.S. Treasury Secretary and economist, Summers, stated that there were indeed many reasons to worry about the long-term path of the U.S. fiscal deficit, but the ability of the U.S. government to repay its debts is not in question. He criticized Fitch's move to downgrade the U.S. credit rating.
Wall Street institutions were quick to respond. Several Wall Street insiders believe Fitch's downgrade will not heavily impact the market.
No Significant Impact on U.S. Stocks, Bonds, or Currency - Dimon Claims the Impact Isn't Significant
Jamie Dimon, CEO of the U.S.'s largest asset bank JPMorgan Chase, remarked that the actual impact of Fitch's downgrade of the U.S. rating was not as significant as it seemed. Moody's had only highlighted some issues that everyone already knew about. The U.S.' credit condition remains good and should have the highest rating globally.
Dimon stated that the U.S. economic condition is quite good, supported by the strength of consumers and businesses, a low unemployment rate, and a healthy balance sheet. However, the economy could still face unexpected challenges. Dimon is most concerned about geopolitical risks associated with the Russia-Ukraine conflict and the Federal Reserve's balance sheet reduction, or so-called quantitative tightening (QT).
Allianz's chief economist, Mohamed El-Erian, labeled Fitch's downgrade of the U.S. rating as "strange". He anticipates it will not impact the market.
Goldman Sachs economist Alec Phillips believes that the Fitch downgrade mainly reflects management and medium-term fiscal challenges and does not provide new fiscal information. The downgrade will not have any direct impact on the financial market as the primary holders of U.S. bonds are unlikely to be forced to sell due to a rating change.
Joachim Klement, director of strategy, accounting, and sustainable development at Liberum Capital, stated that Fitch's downgrade will not have a substantial impact on the stock market, U.S. bonds, or the dollar. He compared the downgrade to a storm in a teacup and said it made sense, but there's no reason to sell U.S. bonds as there are no alternatives in the global debt market and no significant default risk in the next decade.
No Repeat of S&P Downgrade in 2011 - Market Retreat is Temporary
Some people have compared this downgrade to the market's reaction following S&P's downgrade of the U.S. rating in August 2011.
Chris Harvey, head of equity strategy at Wells Fargo, commented that the macro environment is entirely different, and Fitch's downgrade will not have the same impact on the financial market as S&P's downgrade. After S&P's downgrade, the market entered a risk-avoidance mode, stocks adjusted, the credit bond yield spread widened significantly, and interest rates fell. This year, however, the investment-grade credit yield spread hit a low, interest rates were already climbing, the S&P 500 index has increased by 20% since the beginning of the year, and many investors and the Federal Reserve were expected to cut interest rates at the beginning of the year. Thus, any stock market retreat would be relatively temporary and small in scale.
Manish Kabra, head of U.S. equity strategy at Societe Generale, stated that after S&P's downgrade in 2011, the market rapidly responded with significant risk-avoidance action. However, the nominal growth outlook this time is much higher than in 2011, so he anticipates any profit-taking would be temporary. If U.S. bond yields could fall, it would signal the end of significant risk-avoidance. Most institutional investors hope to see the yield curve turn positive before buying stocks, and Societe Generale also hopes to see this major change before upgrading stock ratings to overweight.
Market Downturn Mainly Due to Economic Slowdown Risks, Not Downgrade
Some analysts pointed out existing downside risks in the market.
Alexandre Baradez, chief market analyst at IG in Paris, commented that it felt as if the market was looking for an excuse to take profits. He suspects the market is not pricing in the Fitch downgrade but the increased risks of an economic slowdown. After the two largest economies released some data this week, a downward trend began to appear on Tuesday, indicating that the market is actually reacting to economic slowdown risks, not the Fitch downgrade.
Mark Dowding, CIO of RBC BlueBay Asset Management LLP, stated that overall, the impact of the Fitch downgrade is not significant. However, it serves as a reminder that the U.S. Treasury will issue a large amount of debt. If this leads to a steepening of the bond yield curve and an increase in the discount rate of long-term cash flows, it could pressure the global market. In recent weeks, investors have been betting on a "Goldilocks" scenario for the U.S. economy - not too hot, not too cold - which caused previously firm short sellers to surrender. But as market pricing begins to reflect this perfect state of the economy, it essentially becomes more susceptible to corrective blows.
Dollar Could Soften for Several Days, But Will Sustain No Damage
Some analysts mentioned potential impacts on the dollar.
Carol Kong, currency strategist at the Commonwealth Bank of Australia, believes that if the market thinks the downgrade will weaken the dollar's reserve currency status, the dollar may soften over the next few trading months. However, she anticipates no harm will come to the dollar. Credit ratings are usually not the primary medium-term drivers of a currency.
Andrew Ticehurst, interest rate strategist at Nomura, noted that the dollar's performance might be less robust than some other major currencies like the euro and the yen. If the Fitch downgrade leads to some broad risk-avoidance action, then currencies with higher beta coefficients in Asia might perform poorly. If some risk-avoidance price action occurs across asset classes due to the Fitch downgrade, currency might flow into defensive assets, including highly liquid U.S. bonds.
