Early moves in U.S. financial markets on Wednesday indicated some aversion to riskier assets as investors assessed the impact of the surprise downgrade.
Stock index futures fell, with Nasdaq futures down 0.7%, while Treasury yields slid by 3 basis points. The dollar climbed 0.2%, after slipping broadly in the wake of the downgrade.
Fitch Ratings on Tuesday cut its rating on U.S. long-term foreign-currency debt by one notch to ‘AA+’, citing fiscal deterioration over the next three years and repeated debt ceiling negotiations that threaten the government’s ability to pay its bills.
“Investors have lived through the S&P downgrade in 2011 and remember coming away unscathed. Another might be that people have gotten used to an elevated level of deficit spending,” said Steven Zeng, strategist at Deutsche Bank.
“We see the market impact from the downgrade news as ultimately limited, and Friday’s jobs report could trump the downgrade news as monetary policy is still the dominant driver for yields.”
The 10-year U.S. Treasury yield declined about 3.6 basis points (bps) to 4.0109% immediately after Fitch’s decision, indicating investors’ preference for safer assets. “The Treasury market was highly volatile in the wake of S&P’s downgrade in 2011, but the underpinnings of the U.S. economy were very different then… given the resilience of the U.S. economy and the tightness of labor markets,” said J.P.Morgan rate strategist Jay Barry.
Data released last week showed the U.S. economy grew faster than expected in the second quarter as a resilient labor market supported consumer spending, with markets now pricing in a soft-landing scenario for the economy despite rapid interest rate hikes by the Federal Reserve.
J.P.Morgan also noted that the spending cuts that ended the debt ceiling crisis of 2011 reduced federal spending by 0.7% of Gross Domestic Product (GDP) the following year, while the deal signed into law earlier this year is expected to lower federal spending by less than 0.2% of GDP next year.
Markets took comfort when Fitch did not adjust U.S. “country ceiling”, which it affirmed at AAA, showing strength in the ability of the corporate sector to convert local currency into a foreign currency for debt repayments.
“If Fitch had also lowered the country ceiling, it could have had negative implications for other AAA-rated securities issued by U.S. entities,” said Goldman Sachs economists led by Jan Hatzius.
Moody’s still holds a ‘Aaa’ rating on U.S. government debt. In a review in July, it cited economic strength, “extraordinary” funding capacity, and “central roles of the U.S. dollar and the U.S. Treasury bond market in the global financial system.” (Reporting by Susan Mathew in Bengaluru; Editing by Saumyadeb Chakrabarty)