Credit Downgrade Shocker: Fitch Happens!
Aug 2, 2023
After the U.S. avoided defaulting on its debt in June, no credit rating agencies made any significant announcements - that is until yesterday.
Fitch Ratings announced that it was downgrading the U.S. credit rating from ‘AAA’ to ‘AA+’, citing “the expected fiscal deterioration over the next three years, a high and growing general government debt burden, and the erosion of governance … over the last two decades that has manifested in repeated debt limit standoffs and last-minute resolutions.”
According to Fitch Ratings, here are the criteria for credit ratings:
U.S. equities initially fell on the news in overnight futures markets, and gold rallied. U.S. Treasury bonds and the U.S. dollar rallied as well. Traders levied their vote and decided that this news was more negative for general risk appetite rather than something that would drag down US-centric and USD-denominated assets.
The initial reactions pale in comparison to the carnage that was unleashed on markets in August 2011, when S&P Global Ratings downgraded the U.S. credit rating from ‘AAA’ to ‘AA+’, which yielded four consecutive days of +/-5% swings in stocks. Since the Fitch Ratings announcement,
U.S. equity futures were down less than -1% today prior to the release of the July U.S. ADP Employment Change report (which provoked a spike in U.S. Treasury yields and a bigger pullback in U.S. equities).
The timing of the U.S. credit rating downgrade comes against a backdrop of complacency in markets. In last week’s and this week’s episode of Let Me Explain, we discussed how the seasonal tendency for volatility to rise in August and September could be a headwind for stocks, which may be due for a period of corrective price action.
Certainly, the price action shaping up today is starting to undercut what has been a reliably bullish trend in stocks for the past three months; further technical damage would warrant an immediate reassessment of the near-term outlook, with more downside becoming increasingly likely in E-mini S&P 500 futures (/ES), E-Mini Nasdaq futures (/NQ), E-mini Russell 2000 futures (/RTY) and E-mini Dow $5 Futures and Options (/YM).
Christopher Vecchio, CFA, tastylive’s head of futures and forex, has been trading for nearly 20 years. He has consulted with multi-national firms on FX hedging and lectured at Duke Law School on FX derivatives. Vecchio searches for high-convexity opportunities at the crossroads of macroeconomics and global politics. He hosts Futures Power Hour Monday-Friday and Let Me Explain on Tuesdays, and co-hosts Overtime, Monday-Thursday. @cvecchiofx
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