Just as Wall Street recovered nicely on Friday from another bout of bond market jitters on Thursday, Moody’s threw an enormous spanner in the works by pushing its US credit rating to a AAA negative from the long held AAA stable.
Moody’s move – announced after trading had finished on Wall Street for the week – means it is one step away from dropping America’s rating under the highest level of AAA, meaning the world’s supposed reserve currency and main trade pricing mechanism would not longer have the highest possible rating.
Moody’s is the only one of the three major ratings groups (the others are S&P Global and Fitch) to have the US on a AAA rating. AAA is the highest there is and would mean the US, the cornerstone of the global financial system, woukl have a credit standing lower than that of countries such as Australia, Singapore, Canada, Sweden, Luxembourg and Germany).
Friday saw the Dow jump 391.16 points, or 1.15% to close at 34,283.10, the S&P 500 climb 1.56% to end the week at 4,415.24 and the tech heavy Nasdaq regained some of its poise with a 2.05% jump to end at 13,798.11 for its best single day’s trading since May.
All 11 sectors of the S&P 500 were positive Friday, but tech outperformed, rising 2.6%. Microsoft leapt to all-time highs during the session and ended the day higher by 2.5%. Apple, Meta, Tesla and Netflix jumped more than 2% each, while Alphabet gained 1.8%.
Friday's surge lifted the three major averages for a second consecutive week of gains. The S&P 500 advanced 1.3%, while the Dow added about 0.7%. The Nasdaq was the outperformer, rising roughly 2.4% on the week.
Fitch though provided a reminder of just how temporary this bonhomie in the markets was on Friday. US bond yields edged lower with the 10 year yield ending down 2 points at 4.64%, more than 12 points lower over the week.
The US dollar was mixed, rising against currencies but weaker against the euro, yen and pound. the Aussie dollar slipped to around 63.60 US cents, down 2.35% over the week.
Now Fitch has reminded all the optimists that they face a week of potential tremors and increased volatility because of not only the funding deadline on Friday, but October inflation data Wednesday, Australian time, and the meeting between President Biden and President Xi in San Francisco also on Wednesday.
Before Moody’s move on Friday, Fitch had shocked markets on August 1 when it cut America's rating to AA plus, joining S&P Global which cut its rating back in 2011. The catalyst in both cases was the growing instability in Washington, the intransigence of the Republicans and the stupid debt limits at a time when it looked like the US would default on its debt.
An extension was agreed two days before that deadline – the new deadline is this Friday and the hardline Republicans in the US House of Representatives look like they want to take America to the brink once again.
In announcing its move, Moody’s, pointed to rising risks to the nation’s fiscal strength.
And while the ratings agency affirmed the long-term issuer and senior unsecured ratings of the U.S. at Aaa, its now on a footting that indicates a possible downgrade in the next 18 months.
“In the context of higher interest rates, without effective fiscal policy measures to reduce government spending or increase revenues,” the agency said. “Moody’s expects that the US’ fiscal deficits will remain very large, significantly weakening debt affordability.”
Brinkmanship in Washington has also been a contributing factor, Moody’s said.
“Continued political polarization within US Congress raises the risk that successive governments will not be able to reach consensus on a fiscal plan to slow the decline in debt affordability,” the ratings agency said.
As far as keeping the nation’s ratings at Aaa, Moody’s said that it expects the U.S. to “retain its exceptional economic strength.” “Further positive growth surprises over the medium term could at least slow the deterioration in debt affordability,” the ratings group said.
A top analyst at Moody's said political polarization in the United States will likely complicate budget-making decisions ahead of the 2024 presidential election, which could delay any change of the rating agency's outlook on the government back to a stable outlook.
Moody's changed the U.S. credit outlook to negative from stable on Friday, citing larger fiscal deficits and a decline in debt affordability.
"Any type of significant policy response that we might be able to see to this declining fiscal strength probably wouldn't happen until 2025 because of the reality of the political calendar next year," William Foster, a senior vice president at Moody's, told Reuters.
Moody's typically "resolves" an outlook, meaning in case of a negative outlook it either brings it back to stable or goes ahead with a rating downgrade, within 18 to 24 months, he said. But the process may take longer and will depend on fiscal policy measures that will be taken.
Moody's lower outlook comes after a bond selloff that has pushed long-term Treasury debt yields to levels not seen since 2007 in recent weeks.
An environment of higher interest rates will likely result in higher interest payments and higher deficits, said Foster.
“And so, the question from our perspective moving forward is to what extent the government will be able to address that through fiscal policy measures that will reduce deficits moving forward, either through higher revenues, or reducing primary spending,” he said.
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On Saturday, the new Republican speaker of the US House of Representatives Mike Johnson on Saturday announced a two-step temporary funding measure aimed at averting a partial government shutdown this Friday 9at midnight, Washington time, or 4pm Saturday, Sydney time).
The proposal would provide funding for some segments of the federal government until mid-January and for other agencies until February. It is unlikely to win support from Democrats or the White House.
The Republican-controlled House and Democratic-led Senate have until Friday to enact temporary funding legislation, commonly known as a continuing resolution, to keep federal agencies open after current funding expires.
