Sunset Market Commentary

Markets

Fitch’s US rating downgrade from the top AAA to AA+ (stable outlook) didn’t go uncommented. Fitch cited a worsening budget situation, a high and growing debt burden and an erosion of governance (ie. narrowly avoiding a default as debt ceiling discussions get resolved at the eleventh hour) as reasons for the move. US Treasury Secretary Yellen already yesterday evening lashed out at the rating agency, calling its decision arbitrary and based on outdated data. Prominent economists including former Treasury Secretary Summers said that there are indeed reasons to be concerned about the long-run trajectory of the US deficit but added that the country’s ability to service debt wasn’t in doubt. Others were “puzzled” about the “strange move”, and shouldn’t impact markets much. Evidence from the past (eg. with S&P 2011 US rating cut) indeed shows effects, if any, are limited and temporary. The largest moves were visible on equity markets. In Asian dealings, stock indices lost up to 3% and more. European markets opened lower and then extended losses up to 1.75% (EuroStoxx 50) before paring them to about 1% currently. We nevertheless feel that the Fitch decision was seen as an excuse for some profit-taking after a strong July month rather than anything else. US equity futures also pared their losses, resulting in a lower opening of 0.4-1.3%. US government bonds at the center of all the fuzz at first … strengthened. Marginally, but still. That too is a copy paste of the 2011 script, when rating agency S&P also lowered the US’s AAA rating a notch over the debt ceiling. Back then, US bonds outright surged although circumstances were not all the same (European debt crisis, ultra-low policy rates, Fed shortly after announced a second round of “Operation Twist”). The minor UST advance was later undone by a strong ADP job report though. Some 324k jobs were created in July, crushing consensus for 190k. The figure for June saw a downward 42k revision but does little to counterbalance the big beat. Leisure and hospitality (+201k) are again driving growth, ADP said. It added that manufacturing remains a point of weakness, with the interest-rate sensitive industry shedding jobs for the fifth month straight (-36k). “The economy is doing better than expected and a healthy labor market continues to support household spending. We continue to see a slowdown in pay growth without broad-based job loss.”, the ADP chief economist summarizes. US yields currently add 2.1-7.8 bps across the curve with the 10-y moving further north of the 4% barrier. German Bunds hugely outperform by shedding 2.4-7 bps. The dollar rose against most peers, including the euro – even as the common currency was doing pretty well itself. EUR/USD loses further territory towards 1.095. DXY extends a winning streak to 102.5. Cyclicals and other more risky currencies including AUD, NZD and SEK all feel selling pressure as does sterling. EUR/GBP rises well above 0.86(2).         

News & Views

The Bank of Japan’s deputy governor and one of the key policy architects said Friday’s tweak to the yield curve control programme should not be seen as moving towards an exit from its ultra-easy stance. It is aimed at “patiently continuing with monetary easing”. He also pushed back against any expectations for a rate hike soon, saying that would mean the BoJ is in a state where it needs to cool the economy to address high inflation. The latter is still well above the 2% target but the central bank holds on to the view that it is the result of cost-push factors. Since Friday’s tweak, the Japanese 10y yield surged beyond 0.60%. The move was so abrupt the BoJ intervened on Monday with  unscheduled bond buying. Uchida said there is no specific level at which the BoJ would step in again. He did say that they will, depending on the speed at which it is reaching 1% (the de facto new 10-y rate cap). The 10-y yield today adds another 2 bps to 0.638%, the highest in nine years.

The US Treasury boosted the auction size for the upcoming August-October quarter compared to the May-July quarter as it seeks to restore its depleted cash balance and to fund a bigger than in May expected deficit. It is the first time it did so in over two years. For maturities from 2y up to 7y, the size will increase between $1 bn  to $3 bn in every month from August on. Maturities from the 10y over 20y to 30y will get a significant one-time boost this month before scaling down by $3 bn again for the final two months of the quarter. The US next week kicks off its mid-month refinancing operation through a 3-y, 10-y and 30-y auction. The combined surplus compared to the first month of the previous quarter amounts to $7bn (or $103 bn in total).