Nasdaq led the sell-off in US equities, but the real reason might not be events in the debt markets. Traders paid attention to yesterday’s Fitch downgrade of US credit, to AA+ from AAA, but what did it really mean? “Why now?” was the succinct comment of legendary bond investor, Mohamed El-Erian. “When you look at the reason, you scratch your head as to the timing of this.” S&P’s rating on US debt remains at AA+. Stating the obvious is not a good explanation for the sell-off in stocks. The Fitch downgrade could mean higher interest rates on both public and private debt. However, bond yields rose marginally and dollar was stable – not what you might expect. Elsewhere, service sector employment data reflected a solid economy, a tight labor market and wage inflation pressures ahead of Friday’s Non Farm Payroll report.
TODAY’S MAJOR NEWS
Fitch downgrade states the obvious – the US has a huge debt problem
What prompted the downgrade? “In Fitch’s view, there has been a steady deterioration in standards of governance over the last 20 years, including on fiscal and debt matters, notwithstanding the June bipartisan agreement to suspend the debt limit until January 2025,” the credit rating agency stated. Yes, what’s new? Debt management has been pretty dysfunctional for years. A deal on the debt ceiling was deferred until January 1, 2025, after the next election, to be achieved by a lame-duck Congress, and a lame-duck president. One of the most significant decisions regarding the future of the US economy may be determined by people no longer accountable to voters.
The scale of the debt problem is certainty worrisome. US national debt currently stands at $32.7 trillion, with annual interest payments estimated to be $651 billion, up nearly $300 billion over the past year as interest rates rise. The full impact of the rate hikes have not yet been fully factored into annual interest payments, as some debt certificates at low rates haven’t yet matured, and rolled to the higher current rates. For context, the current annual interest on the debt compares to the $790 billion the US spends annually on national defense. USdebtclock.org estimates that maintaining the status quo will increase the national debt to $44 trillion four years from today, with annual interest payments of $2.8 trillion. That would far exceed the $912 billion estimated cost of national defense in four years, the $1.8 trillion in annual Social Security payments, or the estimated $2.3 trillion in Medicare and Medicaid payments four years from now.
Put simply, unless it is meaningfully reduced In other words, the US debt will blow up its national budget in the next few years. There are three possible solutions to the problem: massive tax hikes, potentially doing significant damage to the economy; significant cuts in entitlement programs, which neither political party has shown the courage to do; or to monetize the debt, certainly inflationary, possibly leading to the collapse of the dollar. So, Fitch is right to worry – but it’s also stating the obvious facts which no one, let alone politicians, wish to face.
Oil and gasoline stocks below seasonal averages for July
- Crude oil prices briefly spiked when the Department of Energy reported that commercial stocks fell by 17.0 million to 439.8 million barrels in the week ending July 28, roughly 1% below levels typically seen in late July
- Gasoline stocks rose by 1.5 million barrels during the week, 6% below seasonal levels
- Distillate stocks fell by 0.8 million barrels, roughly 15% below the five-year average for the week
- Ethanol stocks slipped to 22.9 million barrels in the week ending July 28, down from 23.2 million the previous week
- Reuters reported this morning that the Biden Administration is divided on whether to grant a request from the US biofuel industry that would make it easier for sustainable aviation fuel made from corn based ethanol to qualify for subsidies under the White House's signature climate law
Private sector job creation remains strong
- The private sector added 324,00 jobs in July according to today’s ADP employment report , well above the expected 185,000, and down from 455,000 the previous month
- This raised concerns ahead of Friday’s government jobs report, which analysts expect to show that the economy created 175,00 jobs in July
Russia strikes Ukraine’s grain export infrastructure, again
Russia hit Ukraine export infrastructure at both Odessa and at Izmail on the Danube River, just across the river from NATO member Romania. The strikes come the day after an Israeli ship led others through the unofficial blockade, bragging about the accomplishment. Russia would have looked weak had it not responded, and it did respond. Early reports suggest that significant damage was done at both locations, although we should get greater clarity in the days ahead. Russia appears determined not to allow Ukraine grain exports over water. The question now is, how far will it go to stop exports over land? It probably doesn’t have to focus a lot on that issue currently, because Ukraine faces enough challenges using those over land channels currently due to logistics issues, objections from Eastern European farmers, and the higher costs that discourage Ukraine farmers from even planting the next year’s crops.
TODAY’S MAJOR MARKETS
- The Fitch downgrade of US sovereign debt unnerved equity markets, with the Nasdaq off 2.2% at the close, and the broader S&P 500 and Russell 2000 were both off 1.4%
- Global markets were also lower, with the FTSE 100 and DAX down by 1.4% and 1.7%, respectively, while the Nikkei 225 fell 2.3% on profit taking
- The VIX, Wall Street’s fear index, saw a meaningful increase to 16.1
Currencies and Bonds
- The dollar index rose 0.3% against a basket of currencies, to 102.6
- Sterling and Euro dollar cross rates were both off by 0.6% , while the Yen fell by 0.3%
- Bonds were spooked by the Fitch downgrade, with yields on 2- and 10-year Treasuries at 4.90% and 4.08% respectively
- Crude oil prices recovered by 0.2% to $79.7 per barrel
- Gold and silver prices were both down 0.2%, to $1,971 per ounce and $23.8 per ounce respectively
- Grain and oilseed prices were notably lower in the broad-based commodity selloff
Analysis by Arlan Suderman, Chief Commodities Economist: Arlan.Suderman@StoneX.com
Market outlook by Paul Walton, Financial Writer: Paul.Walton@StoneX.com