Fitch, by far the smallest of the three major credit rating agencies, this week surprised the markets by downgrading US sovereign debt from the highest AAA rating to AA+. The agency cited “a steady deterioration in standards of governance” over the past two decades “that has manifested in repeated debt limit stand-offs and last-minute resolutions” as one of the major reasons for its decision.
Fitch also noted that it “expected fiscal deterioration over the next three years” and “a high and growing general government debt burden”. Immediately following the announcement, the dollar fell across a basket of currencies – before ticking up again and finishing the week substantially stronger. Although there was a minor equities sell-off on the day led by the technology sector, most of the week’s retracement occurred the day before the announcement.
Yet responses from a range of commentators indicate that this event will be a storm in a teacup, likely to be forgotten by the end of next week. There is precedent here – in August 2011 S&P slashed its own rating to AA+ after an earlier debt ceiling showdown. The US equities fell nearly 7% the next day, but the long-term ramifications were negligible as that loss had been recovered by the next week. Moody’s, the other major rating agency, still maintains a AAA rating on US debt.
Janet Yellen, US Treasury Secretary, described the rating change as “arbitrary and based on outdated data”. Many other commentators note that the US economy remains strong with a soft landing coming into view—the serious long-run fiscal challenges the country faces notwithstanding. The decision has also been described as motivated by political views rather than macroeconomic assessments.
While we believe that sovereign debt is a ticking timebomb that governments in many countries, not just the US, will need to defuse in the next decade, the dollar’s rapid recovery from its fall earlier in the week shows that the time for that reckoning is not yet at hand and, even when the risks are in the US, the dollar remains the world’s safe haven currency.
“Overall, this announcement is much more likely to be dismissed than have a lasting disruptive impact on the US economy and markets.”
– Mohamed El-Erian, president at Queens’ College Cambridge, referring to the Fitch downgrade this week
Global News
- Voters may be changing their minds about current US President Joe Biden and his handling of the economy given what is arguably the best run of economic data so far in his presidency. Inflation is cooling, business investment is rising, job growth is powering on and surveys suggest rising economic optimism among consumers and voters. Voters may be turning upbeat on aspects such as gains from the infrastructure, manufacturing, and climate bills he has signed into law.
- Almost 50% of the stocks listed in the S&P 500 index are expected to see growth in the next year thanks to a softening dollar, which comes as speculation mounts that the Fed will halt its most disruptive monetary-tightening campaign in a generation. The dollar is currently 10% weaker against its developed market peers from its peak in September last year.
- Meanwhile, Apple and Amazon.com’s results, which were released after Thursday’s close, are the next big hurdle for the market’s tech-fuelled rally, and it may be the hardest to clear. Both stocks have been critical to the S&P 500’s advance this year. However, the question remains whether they can provide further gains, given that they trade at high multiples, face headwinds in their core businesses, and have limited direct exposure to artificial intelligence — a key driver behind this year’s jump.
- Apple posted declining sales, the third straight quarter of this trend. It has predicted a similar performance in the current period (fourth quarter), hurt by an industrywide slump that has sapped demand for phones, computers, and tablets. The revenue, however, did surpass analysts’ estimates.
- Amazon’s second-quarter earnings exceeded analysts’ estimates, while it also stated that it expects revenue growth to accelerate. The internet giant said it would cut the pace of spending. Shares rose more than 10% in extended trading.
- Uber Technologies reported net income that surpassed analysts’ expectations, as it was boosted by record ridership volumes. This offers evidence that the ride-hailing giant is officially moving beyond its cash-burning start-up past and making progress on its profitability goals. Analysts had expected a loss, and it reported a profit.
- As at Thursday’s close the S&P was 1.75% down for the week.
Local News
- The local currency, which had been regaining some ground, has made a sharp U-turn, trading at R18.67/$ on Thursday afternoon, down 1.1% on the day, as the dollar strengthened on robust US economic data and expectations of interest rates remaining high.
- John Dludlu from Business Day believes that the ANC’s policy disarray is an opportunity to have the much-needed discourse about fixing failing state-owned enterprises, which are dragging the economy down in their free-fall. Transnet has argued that syndicates have allegedly been tapping into its crude oil pipeline, particularly in Mpumalanga and Gauteng, from at least 2019. This siphoning began to spike this financial year, increasing fears about a lack of security at SOEs.
- Business leaders have warned that the unemployment rate could rise to 38.1% by 2030 unless there is urgent action to solve the country’s energy, logistics and crime crises. The forecast, which compares with a current unemployment rate of 32.9%, was included in a presentation made by business groups in a meeting with President Ramaphosa on Tuesday. It was based on an average economic growth rate of 0.75% if no progress is made on those three impediments. The economy needs to add 3% to GDP growth, or the country risks remaining static, the CEOs also said.
- This week’s FM editorial dissects the commitment made by top CEOs to help resolve South Africa’s problems, saying that, while business has made a firm commitment (as per Discovery CEO Adrian Gore), the same sort of commitment is not evident from government. BusinessLIVE makes a similar point, stating that patriotic CEOs must ensure they get a return on investment for resolving what are government problems in the form of a government with the will to work with them.
- The trade deficit rose last month to R3.54 billion compared with May’s downwardly revised R9.57 billion surplus. This was well below market estimates of a R11.85 billion surplus. This shows that the local economy could become more dependent on foreign funding at a time of heightened geopolitical uncertainty, which would further expose the country to exogenous shocks and financing risk.
- Meanwhile, gross tax revenue collection fell substantially in June, by -7.5% year-on-year, driven by a drop in corporate income tax amid lower mining profits from weaker commodity prices. The decline gives a preliminary idea of the impact of lower commodity prices (and also weaker mining profits) this year on government tax revenue collection.
- The City of Johannesburg’s credit rating has been downgraded by GCR Ratings, an affiliate of Moody’s Investors Service. At the same time, it revised its outlook from stable to negative. This was because of continuing pressures on operating performance as evidenced in “subdued income growth, increasing expenditures and relatively weak collection rates”.
- Absa’s Purchasing Managers’ Index (PMI) showed that manufacturing activity has fallen the most since July 2021 when South Africa experienced deadly riots and looting due to former president Jacob Zuma being jailed. Industrial activity was not only affected by the return of more intensive power cuts, but also by delays in receiving material during the transport disruptions on the N3 corridor.
- Prosus will sell PayU’s Global Payments Organisation, excluding its Indian, Turkish and Southeast Asian operations, to UK-based Rapyd for $610 million in cash as the offshore arm of Naspers streamlines its fintech operations. The deal includes PayU’s local business.
- OUTsurance wants to enter the Irish market in the latter stages of its 2024 financial year, if all goes according to plan. It may also sell its underperforming investment unit OUTvest launched six years ago, because it has failed to gain critical mass.
- As at the time of writing, the rand was 6.3% weaker and the ALSI was down 2% for the week.
Sources: Dynasty, BusinessLIVE, FM, NYT, Bloomberg, WSJ, Stanlib, TechCentral, Moneyweb, SCMP, News24, CNBC, etc.
