Last time this happened it triggered a selloff around the world

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The unexpected downgrade of U.S. government debt sent shockwaves across the economic and political landscapes. In financial markets, the move was met with what amounts to a shrug.

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The last time this happened in 2011, S&P’s downgrade of the U.S. credit rating triggered a selloff in risk assets like equities around the world, but ironically boosted Treasuries as investors sought out havens.

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This time, U.S. stock futures fell as much as 1 per cent overnight before cutting that decline in half as of 7:30 a.m. in New York — a minuscule move for contracts on the S&P 500, an index that’s rallied for five straight months. Reaction was also muted in the Treasury and foreign-exchange markets, with the 10-year yield sliding and the dollar little changed versus major peers.

The general consensus among strategists and fund managers has been that the rating cut should have a limited impact on equities, with Wells Fargo & Co. saying any pullback will be “short and shallow” and Liberum Capital describing the news as a “tempest in a teapot.”

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For some, it’s a good excuse to book some profits after a 19 per cent jump this year in the S&P 500. The index hasn’t had a down day of 1 per cent or more in 47 straight sessions, the longest such streak of calm days since January 2020.

Here’s what analysts and strategists had to say:

Alexandre Baradez, chief market analyst at IG in Paris

“One can have the feeling that the market is looking for excuses to take some profits. But rather than the Fitch downgrade, I suspect that what’s currently being priced is the growing risk of an economic slowdown. The downward trend started to emerge yesterday on the back of disappointing Chinese and U.S. data, which suggests it’s not really about the rating downgrade but rather the risk of a slowdown.”

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Raphael Thuin, head of capital markets strategies at Tikehau Capital

“Today’s market price reaction shows how markets are getting uncomfortable with the long-term sustainability of rising government debt. There’s absolutely nothing new in what Fitch had to say but it puts the finger, in a moment where markets are somewhat febrile, on the issue of over-leveraging in a world of lower economic growth and higher yields. On the mid-term we will enter a cycle of deleveraging and that will progressively add some risk to the market.”

Chris Harvey, head of equity strategy at Wells Fargo & Co.

“Fitch’s downgrade should not have a similar impact to S&P’s 2011 downgrade given the starkly different macro environments and other reasons. Heading into S&P’s Aug 2011 downgrade, markets were in “risk-off” mode, with equities in a correction, credit spreads widening significantly, rates falling, and the GFC was still in the market’s collective conscience. Today, we have almost the opposite: IG credit spreads hit a YTD low of 112bps at month end, interest rates have been floating up, the SPX has returned 20 per cent YTD, and many investors expect the Fed to cut rates by early 2024. As a result we believe any equity market pullback would be relatively short and shallow.”

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Manish Kabra, head of U.S. equity strategy at Societe Generale SA

“The market will initially look at the 2011 playbook when we had a kneejerk, major risk-off reaction. But what’s different this time is the nominal growth outlook which is much higher than 2011, so I expect any profit taking to be short-lived. More broadly, if U.S. bond yields can come down, that would be the signal that we’re getting closer to the end of the major risk-off signal. Before majority of institutional investors come out and buy equities, they would like to see the yield curve go positive. We would like to see that happen too before upgrading equities to a material overweight.”

Mark Dowding, chief investment officer at RBC BlueBay Asset Management LLP

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“On the whole, we don’t see the Fitch downgrade to U.S. as particularly significant. However, it serves as a reminder that there will be heavy ongoing issuance of Treasuries on a forward-looking basis and this is something that can weigh on global markets if this prompts a steepening of the yield curve and a rise in the discount rate for longer-dated cashflows. I would also note that over the past few weeks, investors have been buying into the Goldilocks theme in the U.S. economy, causing entrenched bears to capitulate. However, inasmuch as the market starts to price for perfection, then it will become intrinsically more vulnerable to a correction.”

Joachim Klement, head of strategy, accounting and sustainability at Liberum Capital

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“We think the downgrade of the U.S. credit rating will not have a material impact on equity markets, U.S. Treasuries or the U.S. dollar. While the downgrade came at a surprising moment, it is not unjustified given the large deficit of the U.S. government and the lack of projected deficit reduction in the coming three to five years. But there is no reason to sell U.S. Treasuries or demand an increased risk premium, in our view, since there is no alternative to Treasuries in global bond markets, nor is there any material default risk in the coming decade, in our view. All in all this is a tempest in a teapot.”

Alvin Tan, head of Asia FX strategy at RBC Capital Markets

“U.S. Treasuries are the world’s largest and most liquid sovereign bond market. It’s unthinkable large global bond investors will decide to entirely exclude US Treasuries from their holdings. If they do, what USD-denominated bonds will they hold? Some investors may have to cut, especially the non-U.S. domiciled funds. But I would not be surprised if many of them decided that they needed to change their mandates too in order to keep on holding US Treasuries”

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David Croy, interest rate strategist at Australia & New Zealand Banking Group

“I suspect the market will be in two minds about it – at face value, it’s a black mark against the U.S.’s reputation and standing, but equally, if it fuels market nervousness and a risk-off move, it could easily see safe haven buying of U.S. Treasuries and the USD. It’s finely balanced.”

Andrew Ticehurst, a rate strategist at Nomura

“USD could underperform some of the majors, like EUR and JPY. Higher-beta currencies across Asia should fare less well of course if this news leads to some broad risk-off price action. Ironically, if this headline causes some risk-off price action across asset classes, money will likely flow to defensive assets, and that includes highly liquid US Treasuries.”

With assistance from Lisa Pham, Michael G. Wilson, Chester Yung, Wenjin Lv, Iris Ouyang, Matthew Burgess, Ruth Carson and Farah Elbahrawy.

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