Dow Jones falls after US credit downgrade

Dow Jones futures fall 0.3% after Fitch downgrades US credit rating to AA+.
DJIA is overbought on daily RSI, trading near the 35,750 resistance level.
US July ADP Employment Change arrives at 324K, way above 189K expectation.
Analysts expect Friday’s July Nonfarm Payrolls data to decline to 200K.

The Dow Jones Industrial Average (DJIA) opened half a percentage point lower on Wednesday after Fitch downgraded the US federal government’s credit rating from AAA to AA+. Since the market is risk-off, the Dow is tracking better than the riskier indices. The S&P 500 index has fallen 0.8% at the same time, while the NASDAQ Composite reversed 1.2%

However, the ADP Employment Change data for July arrived before the opening, and provided a big surprise to the upside. The July data showed a positive change of 324K new jobs, well above the 189K expected by analysts. This reading tracked with the 497K ADP estimate from June, which was also an incredible upside surprise.

It is bad news for equity markets since it leads expectations higher for Friday’s Nonfarm Payrolls release. Higher employment gains lead to a tighter labor market and thus could provoke the Federal Reserve (Fed) to raise interest rates again in September.

Dow Jones Industrial Average News: Fitch surprises market with US downgrade

Fitch pulled a play right out of S&P Global Ratings’ playbook on Wednesday, releasing its downgrade on US government debt during the European morning session. S&P famously downgraded the US after a debt standoff in Congress in 2011.

Fitch dropped the US government one notch lower – from AAA to AA+. As it stands, this likely will not mean much for US Treasury yields since the US government borrows in its own currency. Still, the move has led to a sell-off at the riskier end of the market, and so relatively safer components of the Dow index are performing better than the tech and growth-heavy NASDAQ 100 index.

The US government recently overcame a debt standoff with the Republican-controlled House of Representatives in late May. Republicans had refused initially to raise the debt ceiling, but the Democratic Party, led by President Joe Biden, resolved the conflict by agreeing to some budget cuts and an increase in military spending. Fitch blamed an “erosion of governance” in the US and an expanding budget deficit for the downgrade.

IG Markets’ Alexandre Baradez told Bloomberg that she suspected the market was not all that worried about the rating cut but used it as an excuse to take profits. “I suspect that what’s currently being priced is the growing risk of an economic slowdown,” Baradez said. “The downward trend started to emerge yesterday on the back of disappointing Chinese and US data.”

In the case of the US, Baradez is referring to a disappointing July Manufacturing PMI that arrived at 46.4, below the 46.8 reading that analysts expected. The reading demonstrates that US manufacturing remains in a contractionary phase, but it was a tick-up from June.

Nonfarm payrolls could show soft landing or need for more hikes

The market has spent much of the week pondering whether the July Nonfarm Payrolls data will arrive as expected. Analyst consensus comes in at a flat 200K, just a bit below June’s 209K figure.

A much higher reading threatens to upend the soft landing thesis that many in the market have adopted. Even Federal Reserve Chair Jerome Powell said at his press conference on July 26 that a recession seemed less and less likely based on the current data.

A much higher NFP would suggest that the central bank might need to raise interest rates again to ensure that the US’s tight labor market does not lead this year’s pleasant disinflationary picture to end in favor of inflation stalling out near an annualized 4% rather than gradually tracking back to the Fed’s mandate for 2% core inflation.

The market wants July’s fed funds rate hike to be the end of the hiking cycle, and a figure slightly below or in line with 200K consensus would reinforce that narrative.

Additionally, analysts expect the Thursday release of July Services PMI to reflect a reading of 53, slightly down from June’s 53.9 figure. Service sector inflation has been harder for the Fed to control in 2023 than goods (manufacturing) inflation.

Earnings of the week

Wednesday, August 2 – CVS Health (CVS), Shopify (SHOP), PayPal (PYPL), Kraft Heinz (KHC), Humana (HUM)

Thursday, August 3 – Apple (AAPL), Amazon (AMZN), Amgen (AMGN), AirBNB (ABNB)

Friday, August 4 – Enbridge (ENB), Dominion Energy (D), fuboTV (FUBO)

What they said about the market – JP Morgan

JPMorgan surprised many traders on Monday by releasing a client note that said the much-hoped-for “soft landing” was an unlikely outcome for the market. The investment bank said that the Fed and other central banks were likely to keep interest rates high for longer than expected, which would likely hurt weaker companies on the periphery.

"We remain skeptical of this outcome, however, anticipating the inflation decline to prove incomplete, leaving restrictive policies in place that should increase private sector vulnerabilities and end the global expansion."

Inflation FAQs

What is inflation?

Inflation measures the rise in the price of a representative basket of goods and services. Headline inflation is usually expressed as a percentage change on a month-on-month (MoM) and year-on-year (YoY) basis. Core inflation excludes more volatile elements such as food and fuel which can fluctuate because of geopolitical and seasonal factors. Core inflation is the figure economists focus on and is the level targeted by central banks, which are mandated to keep inflation at a manageable level, usually around 2%.

What is the Consumer Price Index (CPI)?

The Consumer Price Index (CPI) measures the change in prices of a basket of goods and services over a period of time. It is usually expressed as a percentage change on a month-on-month (MoM) and year-on-year (YoY) basis. Core CPI is the figure targeted by central banks as it excludes volatile food and fuel inputs. When Core CPI rises above 2% it usually results in higher interest rates and vice versa when it falls below 2%. Since higher interest rates are positive for a currency, higher inflation usually results in a stronger currency. The opposite is true when inflation falls.

What is the impact of inflation on foreign exchange?

Although it may seem counter-intuitive, high inflation in a country pushes up the value of its currency and vice versa for lower inflation. This is because the central bank will normally raise interest rates to combat the higher inflation, which attract more global capital inflows from investors looking for a lucrative place to park their money.

How does inflation influence the price of Gold?

Formerly, Gold was the asset investors turned to in times of high inflation because it preserved its value, and whilst investors will often still buy Gold for its safe-haven properties in times of extreme market turmoil, this is not the case most of the time. This is because when inflation is high, central banks will put up interest rates to combat it.
Higher interest rates are negative for Gold because they increase the opportunity-cost of holding Gold vis-a-vis an interest-bearing asset or placing the money in a cash deposit account. On the flipside, lower inflation tends to be positive for Gold as it brings interest rates down, making the bright metal a more viable investment alternative.

Share: Feed news

Information on these pages contains forward-looking statements that involve risks and uncertainties. Markets and instruments profiled on this page are for informational purposes only and should not in any way come across as a recommendation to buy or sell in these assets. You should do your own thorough research before making any investment decisions. FXStreet does not in any way guarantee that this information is free from mistakes, errors, or material misstatements. It also does not guarantee that this information is of a timely nature. Investing in Open Markets involves a great deal of risk, including the loss of all or a portion of your investment, as well as emotional distress. All risks, losses and costs associated with investing, including total loss of principal, are your responsibility. The views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of FXStreet nor its advertisers. The author will not be held responsible for information that is found at the end of links posted on this page.

If not otherwise explicitly mentioned in the body of the article, at the time of writing, the author has no position in any stock mentioned in this article and no business relationship with any company mentioned. The author has not received compensation for writing this article, other than from FXStreet.

FXStreet and the author do not provide personalized recommendations. The author makes no representations as to the accuracy, completeness, or suitability of this information. FXStreet and the author will not be liable for any errors, omissions or any losses, injuries or damages arising from this information and its display or use. Errors and omissions excepted.

The author and FXStreet are not registered investment advisors and nothing in this article is intended to be investment advice.