Risk-Off Mood Pervades Following Surprise Downgrade Of U.S. Treasuries By Fitch Ratings

(Wednesday market open) A defensive, “risk-off” mood gripped global markets early Wednesday after Fitch Ratings’ surprise downgrade of its rating for U.S. Treasuries to AA+ from AAA. The move sparked a rapid retreat from riskier assets, but the bond market saw little initial reaction. Treasuries initially rose following the news.  

“There is a risk-off tone to the markets, which is counterintuitively supportive to the Treasury market,” notes Kathy Jones, chief fixed income strategist at Schwab. Other than that, she adds, the downgrade isn’t likely to change much. Here’s why:

• There is no new substance in Fitch’s opinion. Markets are aware that U.S. deficits are rising.
• It’s well after the debt-ceiling standoff and before a potential government shutdown this fall.
• There are few investors with a mandate to invest in only AAA securities.
• The Treasury Department is not having difficulty finding buyers for newly issued bonds.

Fitch’s explanation for the downgrade was that it “reflects the expected fiscal deterioration over the next three years, a high and growing general government debt burden, and the erosion of governance relative to AA- and AAA-rated peers over the last two decades that has manifested in repeated debt-limit standoffs and last-minute resolutions.”

Investors should keep in mind that this is not about the ability of the U.S. to service its debt—it’s about the willingness to service the debt.

You might remember that the U.S. suffered a debt downgrade back in 2011, but conditions in the market were quite different then. Heading into that downgrade from S&P, stocks and bond yields were in downtrends. This time, both have been trending higher. Investors shouldn’t necessarily dust off the 2011 playbook, notes Kevin Gordon, senior investment strategist at the Schwab Center for Financial Research.

Only energy and utilities rose in premarket equities trading after the downgrade. Gold rose. The dollar initially slipped but then found its footing. Some analysts questioned the downgrade’s timing coming long after the debt-ceiling battle.

Morning rush

• The 10-year Treasury note yield (TNX) rose 2 basis points to 4.06%, near its 2023 high.
• The U.S. Dollar Index ($DXY) rose to 102.21.
• Cboe Volatility Index (VIX) futures leaped to 15.04 after the downgrade.
• WTI Crude Oil (/CL) were steady at $81.96 per barrel.

Just in

July jobs growth at private firms rose far more than expected at 324,000, according to payrolls processor ADP. Analysts had expected 190,000. Growth was led by services-oriented industries like leisure and hospitality.

The ADP report hasn’t been in line with the official government data recently. In June’s initial ADP report, it estimated nearly 500,000 new jobs. But the government’s Nonfarm Payrolls data came in at 209,000. Consensus for Friday’s Nonfarm Payrolls report is 200,000 (see more below).

Treasury yields jumped after the ADP data, perhaps a sign that investors remain more worried about inflation and a potentially overheating economy than they do about the Fitch downgrade. Yields had fallen slightly after the downgrade.

Eye on the Fed

Futures trading indicates a 15% probability that the FOMC will raise rates at its September meeting, down from 18% yesterday, according to the CME FedWatch Tool. The probability for November is 27%.

Stocks in Spotlight

Advanced Micro Devices AMD delivered some traction with Q2 earnings following several challenging quarters for the semiconductor company. Data center revenue met Wall Street’s expectations, and demand for chips serving the personal computers (PC) market improved, lending credence to AMD’s previous assertion that early 2023 represented a bottom in that struggling space.

The company also highlighted improved customer engagement in artificial intelligence, where analysts say AMD holds second place behind Nvidia NVDA. Guidance for Q3 was slightly below expectations.

Starbucks SBUX arguably disappointed, not meeting Wall Street’s average revenue estimate and missing analysts’ same-store sales growth forecasts. China sales grew sharply and overall operating margin improved, however. One interesting note was the 7% growth of North American same-store sales despite a 1% rise in customer traffic, implying continued pricing power.

Mega-caps wait in wings: If this were a typical week, the high point would be Thursday’s post-closing bell reports from Apple AAPL and Amazon AMZN. Instead, these mega-caps’ earnings might take a back seat to Friday’s July Nonfarm Payrolls report (see more below).

Still, Apple and Amazon will get their moment in the sun. Analysts expect a slight year-over-year decline in earnings and revenue from Apple and a mild improvement from Amazon.

Revenue questions dog Apple: Apple shares rose approximately 50% this year, hit all-time highs, and touched $3 trillion in market capitalization. However, sales fell year-over-year in the two most-recent quarters. When it last reported, Apple said it expected year-over-year Q2 revenue to be similar to the first quarter, with a revenue decline of around 3%.

Last time out, Apple beat Wall Street’s expectations, driven by solid iPhone sales. At the same time, Mac, Services, and iPad revenue failed to meet analysts’ forecasts. That means those products could come under scrutiny when Apple reports. Is Apple increasingly dependent on iPhone sales?

It’s worth noting that Apple’s Services segment—the division behind iCloud, Apple Pay, and more—is a margin leader. It continued to grow annually in the prior quarter, by 5.5%, but growth retreated sequentially. Quarterly improvement there would likely lift spirits in the margin camp.

Cloud over Amazon: The cloud market is likely top of mind when Amazon reports. There’s been a multi-quarter slowdown in growth for Amazon Web Services (AWS) amid competition from companies like Microsoft MSFT, Alphabet GOOGL, Oracle ORCL, and IBM IBM. AWS grew 16% year-over-year in Q1 to $21.4 billion—well below the level a year or two ago and down from 20% in Q4 2022. Amazon saw “companies spending more cautiously in this business environment.”

Shadows from the cloud market grew last month after Microsoft’s cautious forecast, though Microsoft’s quarterly results looked solid. Still, there may be continued worries for Amazon after the company’s finance chief said on the last earnings call that the cloud slowdown continued in April, with revenue growth rates about 500 basis points below Q1. That’s a significant decline, and Q2 earnings could rattle investors if that lower pace continued in May and June. Nevertheless, Amazon said last quarter that it likes the fundamentals in AWS and anticipates “much growth ahead.”

What to Watch

Jobs fair: As the clock ticks toward July’s Nonfarm Payrolls report Friday morning, there’s a divergence in views. Wall Street’s consensus for new jobs remains at 200,000—down from 209,000 in June—with unemployment unchanged at 3.6%, according to Trading Economics. That’s still a strong number historically even if it’s down from the three-month average of 244,000. The recent decline in initial jobless claims could set us up for a surprisingly strong reading, says Randy Frederick, managing director of trading and derivatives at the Schwab Center for Financial Research.

On the other hand, the latest job openings and manufacturing data released Tuesday contained nuggets that could point toward weaker jobs growth. Some analysts say even a number as low as 100,000 might be on the table. That kind of reading would potentially spark recession concerns.

Weekly Initial Jobless Claims are due out tomorrow before the opening bell. Analysts see a low number again at 225,000, according to consensus from Briefing.com.

Thinking cap

Ideas to mull as you trade or invest

Recession watch: The economy arguably has been in a “rolling recession,” showing weakness in some sectors and not others (strong services and weak goods, for example). One argument against any near-term descent into full-blown recession is the resilient jobs market. Strength in labor could reflect employers being unwilling to sack employees after facing nearly unprecedented challenges retaining or hiring workers during and after the height of the COVID-19 pandemic. Consumer spending drives the economy, and if unemployment remains low, it could continue to prop growth longer than in past cycles. Earnings season has reinforced ideas that consumers have their wallets open, especially if you look at consumer-oriented companies like airlines, food delivery firms, hotels, and restaurants.

Do not pass Go: How long can exuberant consumer spending persist? That was the main question after the release of the Fed’s quarterly Senior Loan Officer Opinion Survey (SLOOS) this week. It’s just one report, but it showed banks’ growing reluctance to lend, which often can force businesses and consumers to pull back. A small business that can’t get a loan might not hire new employees or might lay off existing ones. A bigger business could decide not to build a new plant or to scale back plans, potentially cutting into jobs growth for construction workers and architects. A tighter loan environment also affects individuals, if, for example, they can’t buy a new car, spend as much on credit, or build an addition. These decisions affect the jobs picture. Fewer workers mean less spending, and even worries of potential job loss can spark thriftiness. Areas to monitor for consumer spending include travel, restaurants, and big-ticket items like automobiles, housing, washers, and phones. Check earnings later this month from big retailers, because strength at discount stores like Walmart (WMT) and Dollar General (DG) could suggest people cutting back. So could strength in private-label brands over name brands.

Data Redux: Yesterday’s July ISM Manufacturing Index and June Job Openings and Labor Turnover Survey (JOLTS) had mixed implications. The ISM headline of 46.4 was in contractionary territory below 50 and has been under 50 all year. New Orders contracted for the 11th straight month. Going back to the 1940s, this long a streak has never been recorded without a recession, notes Schwab’s Kevin Gordon. JOLTS, however, had some “Goldilocks” elements. Job openings of 9.582 million fell from a downwardly revised 9.616 million in May, which could indicate a narrowing gap between workers seeking jobs and companies seeking workers.

Calendar

Aug. 3: June Factory Orders, July ISM Non-Manufacturing Index, and expected earnings from Amazon (AMZN), Apple (AAPL), Coinbase (COIN), Amgen (AMGN), Alibaba (BABA), Hyatt Hotels (H), and Kellogg (K)

Aug. 4: July Nonfarm Payrolls and expected earnings from Dominion Energy (D), Enbridge (ENB), and Corebridge Financial (CRBG)

Aug. 7: June Consumer Credit and expected earnings from Palantir (PLTR) and BioNTech (BNTX)

Aug. 8: Expected earnings from Eli Lilly (LLY), Fox Corporation (FOXA), UPS (UPS), Lyft (LYFT), Wynn Resorts (WYNN), and AMC Entertainment (AMC)

Aug. 9: Expected earnings from Walt Disney (DIS)

(Wednesday market open) A defensive, “risk-off” mood gripped global markets early Wednesday after Fitch Ratings’ surprise downgrade of its rating for U.S. Treasuries to AA+ from AAA. The move sparked a rapid retreat from riskier assets, but the bond market saw little initial reaction. Treasuries initially rose following the news.  

“There is a risk-off tone to the markets, which is counterintuitively supportive to the Treasury market,” notes Kathy Jones, chief fixed income strategist at Schwab. Other than that, she adds, the downgrade isn’t likely to change much. Here’s why:

• There is no new substance in Fitch’s opinion. Markets are aware that U.S. deficits are rising.
• It’s well after the debt-ceiling standoff and before a potential government shutdown this fall.
• There are few investors with a mandate to invest in only AAA securities.
• The Treasury Department is not having difficulty finding buyers for newly issued bonds.

Fitch’s explanation for the downgrade was that it “reflects the expected fiscal deterioration over the next three years, a high and growing general government debt burden, and the erosion of governance relative to AA- and AAA-rated peers over the last two decades that has manifested in repeated debt-limit standoffs and last-minute resolutions.”

Investors should keep in mind that this is not about the ability of the U.S. to service its debt—it’s about the willingness to service the debt.

You might remember that the U.S. suffered a debt downgrade back in 2011, but conditions in the market were quite different then. Heading into that downgrade from S&P, stocks and bond yields were in downtrends. This time, both have been trending higher. Investors shouldn’t necessarily dust off the 2011 playbook, notes Kevin Gordon, senior investment strategist at the Schwab Center for Financial Research.

Only energy and utilities rose in premarket equities trading after the downgrade. Gold rose. The dollar initially slipped but then found its footing. Some analysts questioned the downgrade’s timing coming long after the debt-ceiling battle.

Morning rush

• The 10-year Treasury note yield (TNX) rose 2 basis points to 4.06%, near its 2023 high.
• The U.S. Dollar Index ($DXY) rose to 102.21.
• Cboe Volatility Index (VIX) futures leaped to 15.04 after the downgrade.
• WTI Crude Oil (/CL) were steady at $81.96 per barrel.

Just in

July jobs growth at private firms rose far more than expected at 324,000, according to payrolls processor ADP. Analysts had expected 190,000. Growth was led by services-oriented industries like leisure and hospitality.

The ADP report hasn’t been in line with the official government data recently. In June’s initial ADP report, it estimated nearly 500,000 new jobs. But the government’s Nonfarm Payrolls data came in at 209,000. Consensus for Friday’s Nonfarm Payrolls report is 200,000 (see more below).

Treasury yields jumped after the ADP data, perhaps a sign that investors remain more worried about inflation and a potentially overheating economy than they do about the Fitch downgrade. Yields had fallen slightly after the downgrade.

Eye on the Fed

Futures trading indicates a 15% probability that the FOMC will raise rates at its September meeting, down from 18% yesterday, according to the CME FedWatch Tool. The probability for November is 27%.

Stocks in Spotlight

Advanced Micro Devices (AMD) delivered some traction with Q2 earnings following several challenging quarters for the semiconductor company. Data center revenue met Wall Street’s expectations, and demand for chips serving the personal computers (PC) market improved, lending credence to AMD’s previous assertion that early 2023 represented a bottom in that struggling space.

The company also highlighted improved customer engagement in artificial intelligence, where analysts say AMD holds second place behind Nvidia (NVDA). Guidance for Q3 was slightly below expectations.

Starbucks (SBUX) arguably disappointed, not meeting Wall Street’s average revenue estimate and missing analysts’ same-store sales growth forecasts. China sales grew sharply and overall operating margin improved, however. One interesting note was the 7% growth of North American same-store sales despite a 1% rise in customer traffic, implying continued pricing power.

Mega-caps wait in wings: If this were a typical week, the high point would be Thursday’s post-closing bell reports from Apple (AAPL) and Amazon (AMZN). Instead, these mega-caps’ earnings might take a back seat to Friday’s July Nonfarm Payrolls report (see more below).

Still, Apple and Amazon will get their moment in the sun. Analysts expect a slight year-over-year decline in earnings and revenue from Apple and a mild improvement from Amazon.

Revenue questions dog Apple: Apple shares rose approximately 50% this year, hit all-time highs, and touched $3 trillion in market capitalization. However, sales fell year-over-year in the two most-recent quarters. When it last reported, Apple said it expected year-over-year Q2 revenue to be similar to the first quarter, with a revenue decline of around 3%.

Last time out, Apple beat Wall Street’s expectations, driven by solid iPhone sales. At the same time, Mac, Services, and iPad revenue failed to meet analysts’ forecasts. That means those products could come under scrutiny when Apple reports. Is Apple increasingly dependent on iPhone sales?

It’s worth noting that Apple’s Services segment—the division behind iCloud, Apple Pay, and more—is a margin leader. It continued to grow annually in the prior quarter, by 5.5%, but growth retreated sequentially. Quarterly improvement there would likely lift spirits in the margin camp.

Cloud over Amazon: The cloud market is likely top of mind when Amazon reports. There’s been a multi-quarter slowdown in growth for Amazon Web Services (AWS) amid competition from companies like Microsoft (MSFT), Alphabet (GOOGL), Oracle (ORCL), and IBM (IBM). AWS grew 16% year-over-year in Q1 to $21.4 billion—well below the level a year or two ago and down from 20% in Q4 2022. Amazon saw “companies spending more cautiously in this business environment.”

Shadows from the cloud market grew last month after Microsoft’s cautious forecast, though Microsoft’s quarterly results looked solid. Still, there may be continued worries for Amazon after the company’s finance chief said on the last earnings call that the cloud slowdown continued in April, with revenue growth rates about 500 basis points below Q1. That’s a significant decline, and Q2 earnings could rattle investors if that lower pace continued in May and June. Nevertheless, Amazon said last quarter that it likes the fundamentals in AWS and anticipates “much growth ahead.”

What to Watch

Jobs fair: As the clock ticks toward July’s Nonfarm Payrolls report Friday morning, there’s a divergence in views. Wall Street’s consensus for new jobs remains at 200,000—down from 209,000 in June—with unemployment unchanged at 3.6%, according to Trading Economics. That’s still a strong number historically even if it’s down from the three-month average of 244,000. The recent decline in initial jobless claims could set us up for a surprisingly strong reading, says Randy Frederick, managing director of trading and derivatives at the Schwab Center for Financial Research.

On the other hand, the latest job openings and manufacturing data released Tuesday contained nuggets that could point toward weaker jobs growth. Some analysts say even a number as low as 100,000 might be on the table. That kind of reading would potentially spark recession concerns.

Weekly Initial Jobless Claims are due out tomorrow before the opening bell. Analysts see a low number again at 225,000, according to consensus from Briefing.com.

Thinking cap

Ideas to mull as you trade or invest

Recession watch: The economy arguably has been in a “rolling recession,” showing weakness in some sectors and not others (strong services and weak goods, for example). One argument against any near-term descent into full-blown recession is the resilient jobs market. Strength in labor could reflect employers being unwilling to sack employees after facing nearly unprecedented challenges retaining or hiring workers during and after the height of the COVID-19 pandemic. Consumer spending drives the economy, and if unemployment remains low, it could continue to prop growth longer than in past cycles. Earnings season has reinforced ideas that consumers have their wallets open, especially if you look at consumer-oriented companies like airlines, food delivery firms, hotels, and restaurants.

Do not pass Go: How long can exuberant consumer spending persist? That was the main question after the release of the Fed’s quarterly Senior Loan Officer Opinion Survey (SLOOS) this week. It’s just one report, but it showed banks’ growing reluctance to lend, which often can force businesses and consumers to pull back. A small business that can’t get a loan might not hire new employees or might lay off existing ones. A bigger business could decide not to build a new plant or to scale back plans, potentially cutting into jobs growth for construction workers and architects. A tighter loan environment also affects individuals, if, for example, they can’t buy a new car, spend as much on credit, or build an addition. These decisions affect the jobs picture. Fewer workers mean less spending, and even worries of potential job loss can spark thriftiness. Areas to monitor for consumer spending include travel, restaurants, and big-ticket items like automobiles, housing, washers, and phones. Check earnings later this month from big retailers, because strength at discount stores like Walmart (WMT) and Dollar General (DG) could suggest people cutting back. So could strength in private-label brands over name brands.

Data Redux: Yesterday’s July ISM Manufacturing Index and June Job Openings and Labor Turnover Survey (JOLTS) had mixed implications. The ISM headline of 46.4 was in contractionary territory below 50 and has been under 50 all year. New Orders contracted for the 11th straight month. Going back to the 1940s, this long a streak has never been recorded without a recession, notes Schwab’s Kevin Gordon. JOLTS, however, had some “Goldilocks” elements. Job openings of 9.582 million fell from a downwardly revised 9.616 million in May, which could indicate a narrowing gap between workers seeking jobs and companies seeking workers.

Calendar

Aug. 3: June Factory Orders, July ISM Non-Manufacturing Index, and expected earnings from Amazon (AMZN), Apple (AAPL), Coinbase (COIN), Amgen (AMGN), Alibaba (BABA), Hyatt Hotels (H), and Kellogg (K)

Aug. 4: July Nonfarm Payrolls and expected earnings from Dominion Energy (D), Enbridge (ENB), and Corebridge Financial (CRBG)

Aug. 7: June Consumer Credit and expected earnings from Palantir (PLTR) and BioNTech (BNTX)

Aug. 8: Expected earnings from Eli Lilly (LLY), Fox Corporation (FOXA), UPS (UPS), Lyft (LYFT), Wynn Resorts (WYNN), and AMC Entertainment (AMC)

Aug. 9: Expected earnings from Walt Disney (DIS)

TD Ameritrade® commentary for educational purposes only. Member SIPC.

Image sourced from Shutterstock

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