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Stocks drop, Treasury yields dip after Fitch downgrades U.S. rating

The German share price index DAX graph is pictured at the stock exchange in Frankfurt, Germany, August 1, 2023. REUTERS/Staff/File photo
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(Reuters) – Global shares dropped and Treasury yields dipped on Wednesday after ratings agency Fitch unexpectedly downgraded the United States’ top-tier sovereign credit rating.

Fitch cut the United States by one notch to AA+ from AAA, citing fiscal deterioration, a decision announced after the Wall Street close on Tuesday.

The news hit global stock markets, taking Europe’s STOXX 600 index to a two-week low. The index paired its losses but as of 1112 GMT it was still down 0.8% .

U.S. stocks were also set to open lower with Nasdaq futures having fallen more than 1% in earlier trade. Asia-Pacific stocks dropped earlier, partly amid signs of some weakness in China’s economy.

U.S. 10-year Treasury yields were down 3 basis points, while credit default swaps, which insure exposure to U.S. Treasuries, were little moved, according to S&P Global Market Intelligence data. The U.S. dollar was up just 0.2% against a basket of peers.

“The lack of movement in U.S. Treasury Bonds and the dollar index suggests the market has already largely quantified and assessed the damage done from recent fallouts,” said Sophie Lund-Yates, lead equity analyst at Hargreaves Lansdown.

Fitch’s move, which came after it had placed the ratings on negative watch in May, drew an angry response from the White House, which called it “arbitrary and based on outdated data” as it came two months after a debt ceiling agreement that averted a U.S. default.

“It’s true that this move by Fitch is somewhat based on outdated data, especially with the trajectory of inflation now at a more favourable gradient,” Lund-Yates said.

Investors drew comparisons with what happened when Standard & Poor’s cut the U.S.’s AAA rating in 2011 in the aftermath of the global financial crisis. Investors took refuge from riskier equities by piling into Treasuries then as well, but the rally in bonds was much larger than the move so far this time.

“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,” said Deutsche Bank strategist Jim Reid.

While investors say the downgrade is unlikely to have a big impact on U.S. Treasuries, which underpin the financial system as an unrivalled global safe asset, it has injected some uncertainty into financial markets and cast renewed attention on the debt metrics of the world’s largest economy.

The news also came just after the U.S. Treasury said on Monday it expected to borrow $1.007 trillion in the third quarter, the largest amount ever for that period, compared with May’s $274 billion estimate. Attention was on a Treasury refunding announcement due later on Wednesday.

DISAPPOINTING DATA

The downgrade “basically tells you the U.S. government’s spending is a problem. It’s an unsustainable budget situation because the economy can’t even grow its way out of this problem going forward,” said Steven Ricchiuto, U.S. chief economist at Mizuho Securities.

“Therefore, they’re going to have to either tackle it or accept the consequences of potential further additional downgrades.”

Tony Sycamore, an analyst with IG, said that apart from the Fitch move, there had been some disappointing data in the U.S. and China and some weaker-than-expected earnings, so people were taking money off the table.

Elsewhere, Japan’s 10-year bond yield hit a fresh nine-year peak on Wednesday as investors continued to test the Bank of Japan’s tolerance for higher yields following Friday’s surprise policy tweak. The yen was up 0.4% against the dollar, looking to reverse three sessions of losses.

Attention was still firmly on monetary policy, with uncertainty around how much the Bank of England will hike rates on Thursday. The decision is essentially seen as a coin toss with investors betting on a roughly 60% chance of a 25 basis-point move after an unexpectedly large 50 basis-point increase in June.

Economic data also remained in focus, with the U.S. due to publish fresh jobs market data this week.

Oil prices gained on Wednesday and were trading near their highest since April, after industry data showed a much steeper-than-expected drawdown last week in U.S. crude oil inventories.

West Texas Intermediate crude futures were last up 0.9% to $82.07, while Brent crude rose similarly to $85.57 per barrel.

Gold was last up 0.4% on the day at $1,952.60 per ounce.