Fitch Roils Markets

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Marc Chandler
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Overview: Late yesterday, on the eve of the quarterly refunding announcement, Fitch cut the US rating to AA+ from AAA, citing project fiscal deterioration over the next few years and "the erosion of governance". S&P also has the US as an AA+ credit. Ironically, many observers who have been critical of the US monetary and fiscal policies, like former Treasury Secretary Summers and El-Erian, were also critical of Fitch's decision. The US 30-year yield reached its highest level since last November before Fitch's announcement. It and the 10-year yield are slightly firmer today, ahead of the Treasury's refunding announcement an hour before the US equity markets begin their day session. Note that Moody's continues to rate the US as AAA, and asset managers have idiosyncratic rules of what to do with split ratings.  The ECB takes the highest rating in determining haircuts for collateral.  We suspect the Fitch's decision is more symbolic and embarrassing than having a sustained adverse impact. The dollar is mixed but mostly firmer against the G10 currencies, but the Japanese yen. Emerging market currencies are softer except for the Czech koruna and Polish zloty.

Equities are most impacted today. A couple large bourses in Asia Pacific, including the Nikkei, Hang Seng were off more than 2%, while most of the others fell by more than 1%. Europe's Stoxx 600 is down about 1.35%, which if sustained would be the largest drop in nearly a month. US index futures are 0.6% (Dow) to 1.1% (NASDAQ) lower. Note that when S&P downgraded the US in 2011 the main US indices plummeted 5-7%. Asia Pacific yields played catch-up after the rise in North America yesterday, but European yields are mostly 3-4 bp lower, though UK 10-year Gilt yield is slightly firmer. The US 10-year yield is little changed but holding above 4.0%. Gold is hovering around $1950, and the five-day moving average is set to cross below the 20-day moving average for the first time in three weeks. Meanwhile, oil is extending its recent gains and September WTI traded above $82 a barrel, helped by a dramatic fall in US crude inventories (API reportedly estimated a 15.4 mln barrel drawdown, which is confirmed would be the largest in at least 40 years). Separately, estimates suggest OPEC+ output fell its lowest since 2020 last month.

Asia Pacific

The local session featured a sell-off in stocks and bonds in response to yesterday's US developments. The economic calendar was quiet ahead of tomorrow's Caixin services and composite PMI, Japan and Australia's final services and composite PMI, and Japan's portfolio flows for the week before the BOJ's YCC adjustment. The focus in China is on the new measures taken to support the economy. In Japan, the market continues to adjust to the doubling of the cap on the 10-year JGB, but also the BOJ's unexpected open market operation on Monday to buy the 10-year bond for the first time since February. The 10-year yield has risen by about 17 bp, the 20-year and 30-year yield have risen almost 24 bp. Economic activity in the region continues to moderate and South Korea's July trade figures, released yesterday, underscore this assessment. The 16.5% year-over-year decline in exports was more than expected and follows a 6% decline in June. Exports of semiconductors contracted by 34%, accelerating from the 28% fall previously. Restrictions high-end chips and fabrication equipment to China is taking a toll. South Korea's exports to China are off a quarter compared with a little more than an 8% decline of shipment to the US. Exports to the EU fell by 8.4%. To be sure, it is not only chips. Shipments of oil products were 42% lower than a year ago and steel product exports were off slightly more than 10%. Auto exports were a bright spot, up 15%. South Korea's imports of lithium products for rechargeable batteries rose sharply. Imports from China were off 19.2% and imports from the US were down 20.6% year-over-year. Neither the US nor China have reported July trade figures.

The dollar has retraced yesterday's gains against the yen and has remained within its range of roughly JPY142.20 to JPY143.35. There is scope for some expansion of the range in North America, but it may take a break of the JPY141.45 area to signal a deeper correction rather than sideways consolidation. The $0.6600 area held yesterday for the Australian dollar, but it yielded to the risk-off pressure today and the Aussie tumbled to nearly $0.6565, a two-month low. Note that the lower Bollinger Band is found near $0.6575 today. The low for the year was set on May 31 slightly below $0.6460. Previous support at $0.6600 now becomes resistance and a close above it would help stabilize the tone. The greenback edged up against the Chinese yuan and reached its best level in seven sessions near CNY7.1870. The PBOC set the dollar's reference rate at CNY7.1368 compared with the median projection in Bloomberg's survey of CNY7.1673. Chinese officials are using its soft power to encourage banks to postpone or reduce dollar sales and to reduce mortgage rates.

Europe

There is a lull in economic news from Europe. Tomorrow sees the final services and composite PMI and the eurozone June PPI (deflation). In addition to the final PMI readings, the UK will report the results of inflation expectations from the decision maker panel ahead of the outcome of the Bank of England monetary policy committee meeting. That said, note that the UK's largest lenders are reducing rates on some mortgage products. The market has turned more skeptical of an ECB rate hike in September. After the ECB's decision last week and President Lagarde's press conference, the swaps market priced in around a 72% chance of a hike in September. The odds are now seen closer to 35%. Germany's two-year yield has edged about five basis points lower in the week since the ECB meeting and is off a little more 30 bp from the July peak, near 3.35%. Meanwhile, many had expected tensions to rise with Italy under the Meloni-led government. This has not materialized and the Italy's 10-year premium over Germany has narrowed from above 210 bp at the start of the year to a low in mid-June of almost 155 bp. The unexpected contraction in Italy's Q2 GDP (-0.3%) may reanimate the lingering concerns about Italy's government debt and that could see its premium widen.

The euro extended yesterday's recovery from almost $1.0950 to reach $1.1020 in early Asia Pacific turnover before retreating toward $1.0975. It continues to chop around within last Friday's range (~$1.0945-$1.1045). The intraday momentum indicator is getting stretched ahead of the North American open and the ADP report. Sterling is in a narrow range (~$1.2760-$1.2805). It is setting up for the fourth consecutive lower high. The uncertainty over the size of tomorrow's anticipated BOE hike may be deflecting attention from sterling. Yesterday's low (~$1.2740) was the lowest it has been since July 7. The intraday momentum indicators favor the downside and a retest of the session lows, but we suspect yesterday's $1.2740 is safe.

America

The flurry of US data yesterday did not really contain new information as confirming what we already knew. The manufacturing PMI was steady from the flash reading of 49.0, up from 46.3 in June. The manufacturing ISM told a similar story: some slowing in the pace of decline. It stands at 46.4, up from 46.0. The details were largely consistent with this generalization except for employment (44.4 vs. 48.1). Construction spending rose by 0.5%, and although it missed the median in Bloomberg's survey (0.6%), May's 0.9% gain was revised to 1.1% July auto sales were a little better than June (at 15.74 mln SAAR vs. 15.68 mln) but softer than expected (15.8 mln). JOLTS too softer than expected but consistent with a gradual unwinding of the labor market's tightness. That said, if anything, the decline in job openings was less than expected because it was pushed back in May, which was revised to 9.616 mln from 9.824 mln. June's job openings stood at 9.582k.

Staying with the jobs focus, today sees the ADP private sector estimate. Even though ADP said when it revised is model that its purpose was not to predict the national figures but to add to the information set, including about wages. Still, the ADP estimate had tracked the national estimate of private sector non-farm payrolls closely. Through May, ADP had estimated an average gain of 222k a month, while the BLS estimate was 228k. June was an outlier. ADP estimated the US created 497k private sector jobs. The BLS said 149k. Note that the median forecast in Bloomberg's survey is for private sector payrolls to grow by 180k. 

The broadly stronger US dollar and the risk-off mood drove the Canadian dollar and Mexican peso lower. Canada's manufacturing PMI improved but remained below the 50 boom/bust level (49.6 vs. 48.8). The US dollar tested the CAD1.3300 level where options for about $2 bln expire at the end of the week. The dollar has approached CAD1.3320 and a push above it could signal retest on the July high slightly above CAD1.3385. Given the momentum, the risk may extend to the CAD1.3440-60 area. Mexico's manufacturing PMI rose to 53.2 (from 50.9), a new high, and a smaller than expected decline in worker remittances ($5.57 bln down from $5.693 bln, but above the median forecast in Bloomberg's survey for $5.46 bln). The greenback still extended its recovery from the eight-year low set at the end of last week (~MXN16.6260). It reached MXN16.8660 yesterday and MXN16.9875 today. It is above the 20-day moving average (~MXN16.8880) and last Friday's high (MXN16.95). This is the kind of pullback in the peso that has proven to be opportunistic times to buy the peso. It may take a break below MXN16.85 to boost the chances a high is in place. Brazil, which is expected to cut rates tomorrow, reported a 0.1% rise in June's industrial output figures yesterday. The median forecast was for a decline of that magnitude. Its manufacturing PMI stands at 47.8, up from 46.6 in June. It has not been above 50 since last October. The Brazilian real fell by about 1.2% yesterday, twice the peso's decline. The 20-day moving average is near BRL4.80, and above there, risk extends into the BRL4.82-BRL4.85 band.