Interactive Investor

Stocks stunned by fresh downgrade to US credit rating

2nd August 2023 13:25

Graeme Evans from interactive investor

A revival of fortunes for global equities suffered a setback after a credit ratings agency took a dim view of America’s current predicament. Our City writer explains.

The fallout from a second downgrade to the US credit rating left some London stocks considerably cheaper today as the stellar run for stock markets ground to a halt.

Fitch’s move to follow S&P 12 years earlier by cutting from the top notch to AA+ impacted confidence in Asia and Europe, with the FTSE 100 index 1.7% lower at one point.

Big fallers in London included Scottish Mortgage (LSE:SMT) Investment Trust, which reversed some of its recent gains to leave the Tesla (NASDAQ:TSLA), NVIDIA Corp (NASDAQ:NVDA) and Netflix Inc (NASDAQ:NFLX) investor down 25.2p to 704.4p. Among other blue-chips with US exposure, medical devices firm Smith & Nephew (LSE:SN.) fell 24p to 1,152.5p and JD Sports Fashion (LSE:JD.) lost 2.6p at 150.65p.

The mood steadied as the session wore on, although futures markets still pointed to a downbeat start for leading Wall Street benchmarks this afternoon.

US stocks have rallied sharply in recent weeks, including a run of 13 positive sessions for the Dow Jones Industrial Average on hopes of a soft landing for the US economy as inflation pressures ease and the Federal Reserve nears the end of its policy tightening.

Optimism over the state of corporate America has been backed up by quarterly results, which showed that the 254 of the S&P 500 to report so far have been 4% ahead of consensus.

Today’s selling pressure came even though Fitch had warned in May it could take action, when the US was on the brink of default due to the failure of politicians to raise the debt ceiling,

The agency has grown tired of the repeated wranglings and last-minute resolutions in Congress that it believes have eroded confidence in the country’s fiscal management.

It said the government lacked a medium-term fiscal framework and had a complex budgeting process. “These factors, along with several economic shocks as well as tax cuts and new spending initiatives, have contributed to successive debt increases over the last decade.

“Additionally, there has been only limited progress in tackling medium-term challenges related to rising social security and Medicare costs due to an ageing population.”

Its commentary highlighted a rapidly growing debt burden that has left the ratio to GDP over two-and-a-half times the 'AAA' median of 39.3% and the 'AA' median of 44.7% of GDP.

The Fitch downgrade comes after S&P Global Ratings made the same move when lawmakers were locked in a previous borrowing impasse in 2011. A third agency, Moody’s, has continued to hold on to its AAA rating.

Deutsche Bank strategist Jim Reid said today: “S&P being the first to downgrade 12 years ago was far bigger news and has allowed investors to adjust for the most important bond market in the world not being a pure AAA anymore, but it's still a big decision.”

There are currently nine countries with the full set of AAA ratings, giving investors confidence in their creditworthiness and helping to keep down borrowing costs.

US Treasury Secretary Janet Yellen responded to the Fitch downgrade by calling it “arbitrary” and based on “outdated” data.

UBS Global Wealth Management said: “Though the US now holds two AA+ ratings, we think the latest downgrade does not reflect any new fiscal information and should only have a limited market impact.”

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