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Market Update
August 4, 2023

Downgrading From AAA to AA+

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Week Ending 4 August, 2023

On Tuesday (1st) we saw Fitch downgrade the US from AAA to AA+. The last time this happened was 5th August 2011 when Standard & Poors did the same thing following intense debt ceiling negotiations. The S&P 500 fell heavily, the ViX (Volatility Index) spiked, Treasuries gained strongly (flight -to-quality). The circumstances were quite different back then – the Euro crisis was playing out (Greece) and there was real apprehension. The Fed committed to keeping rates exceptionally low for two years. During Sep. 2011, they extended Treasury operations by selling short-dated securities but bought long-dated instead keeping demand for 10y Treasuries well-buoyed. On the back of plenty of liquidity and support (a Fed PUT), markets settled. Today, the downgrade – coming 12 years later – was more around the fiscal (deficit) balance and tightening monetary conditions and its impact on debt markets. The nature of issued debt is that it has become more short duration. As one commentator said, “it took the Ratings Agency 12 years to figure out another downgrade was due”.

Money markets witnessed substantial inflows on the back of the above (downgrade) but also weak news from Europe and China. $67.52bn flowed into global MM funds this week. Re Europe, things are changing – the June German factory orders jumped the most in three years – a sign the country is stabilising. Demand gained +7% m/m, far in excess of any projection and was driven by major orders. China’s Caixin July’s service sector activity rose to 54.1 (June: 53.9) demonstrating segments such as domestic retail spending and demand are still quite resilient. External demand does still remain weak but today’s result is in contrast to manufacturing which is still in contraction. Caixin (a much wider base of companies) said companies reported improved operating conditions, greater client numbers and new product releases - all helping to boost sales at the start of Q3 this year. The new business sub-index has also picked up though still below average. Sentiment has moderated to an eight-month low and has fallen below the series’ long-run trend. Bit-by-bit, Europe and China are turning around. Not to forget, China is implementing measures to support the economy. Look at the timeline (Reuters):

20th June: cut key lending benchmarks (LPRs) – first time in ten months.

30th June: the PBoC increased relending and rediscount quotas by Yuan200bn to support the farm sector and small firms.

14th July: the cabinet approves guidelines for improving the building of public infrastructure in megacities.

18th July: the Commerce ministry announces a series of measures aimed at boosting household consumption of goods and services.

19th July: the Party and cabinet issued guidelines to support the private economy with some 31 measures.

21st July: the cabinet approved guidelines on transforming urban villages or underdeveloped areas in megacities to support property investment.

24th July: the state planner unveils measures to support private investment in some infrastructure sectors and will strengthen financing support for private projects.

24th July: its leaders pledged more support for the economy and signalled more steps.

28th July: it was reported the housing ministry effectively wants to take steps to lower home mortgage rates and down payment ratios for first-time buyers to spur home purchases.

31st July: the cabinet issues measures to boost consumption in autos, real estate & services.

2nd August: the finance ministry unveils a package of tax reliefs for small businesses and rural households. The measures include: (1) extend a VAT cut for an additional four years to 2027; (2) exempt VAT for those with less than Yuan100,000 in monthly sales; (3) cut the rate on taxable sales revenues to 1%; (4) Interest income arising from microlending to SMEs would be exempt from VAT; (5) an extension of preferential tax terms to 2027 for tech startups with under 300 employees and gross assets and annual sales revenue under Yuan50mn.

From a market point of view, I think analysts have been expecting – and waiting for – a big, bumper stimulus announcement comprising hundreds and hundreds of billions in spending giveaways. That’s not going to happen. China’s cabinet won’t risk it!

Finally, a quick mention on today’s US Nonfarm Payroll release. It was fine! Job gains printed at +187,000, a little below forecasts while June was revised down to 185,000. Healthcare led the way with gains of +63,000. The unemployment rate is 3.5% and is a little above the lowest level since late 1969. Average hourly earnings rose +0.4% m/m to 4.4% y/y - both these numbers were higher than expected. The participation rate held at 62.6% while for those in the 25y to 64y “prime” group dipped a little to 83.4%. The unemployment rate that includes discouraged workers and those holding part-time jobs fell -0.2% m/m to 6.7% while, the unemployment rate based on the household survey, showed a robust job gain of +268,000. Furthermore, if you take the ADP (Private sector) job gains announced two days ago of +324,000, it’s a healthy picture. The ADP number was led by a +201,000 jump in hotels, restaurants, bars and affiliated businesses. ADP also noted a +6.2% y/y gain in wages.

Key thing to note is that the economy needs roughly 100,000 jobs per month to keep pace with growth in the working-age population. Currently, the US is easily average more than twice that. The Fed is not going to cut rates until such time as these job numbers start to slide towards the minimum (100K pm) or even go below it!


Source: Refinitiv Datastream/Fathom Consulting
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