Stocks sink after historic US credit rating downgrade

US markets fell in Wednesday trading following the downgrade of US debt from the highest AAA rating to AA+ by rating company Fitch.

Fitch cited “a steady deterioration in standards of governance” as a major reason behind its decision on Tuesday evening.

A major sell-off, led by the technology sector, followed.

The Dow closed 348 points, or 1%, lower in Wednesday trading. The S&P 500 fell 1.4% and the Nasdaq dropped 2.2%, marking its worst performance since February.

The 10-year Treasury yield hit its highest level since November. Bond prices and yields move in opposite directions, so falling Treasuries boost yields.

Tech megacap stocks like Amazon, Meta, Microsoft, Tesla, Nvidia and Apple led market declines. Because the tech sector is so forward-facing, it’s particularly sensitive to interest rate changes.

Earnings season, meanwhile, is more than halfway through. About 82% of S&P 500 companies have beaten expectations, according to FactSet data.

CVS was up nearly 3.3% after beating earnings expectations Wednesday morning.

Kraft Heinz, meanwhile, also rose more than 1.2% even after reporting that higher prices had led to a slowdown in consumer demand.

Shopify, PayPal, Occidental Petroleum, MetLife, DoorDash, Clorox, MGM Resorts, Marathon Oil, Zillow, Etsy and Robinhood report earnings after market close.

August is a historically bad month for markets because so many investors take vacations and there are decreased trading volumes. This reduced activity can lead to increased volatility.

An aerial view of homes in Hawthorn Woods, Illinois, on July 19.

Mortgage rates rose Wednesday, following Fitch’s downgrade of US debt.

The yield on 10-year Treasuries climbed as high as it had been since November. The fixed rate for a 30-year mortgage tends to follow the yield on the 10-year Treasury note.

“What is happening related to the downgrade of the US debt has really bumped up some of the borrowing costs,” said Lawrence Yun, chief economist at the National Association of Realtors, during a previously scheduled economic summit hosted by NAR.

But Yun questioned how seriously to take the announcement.

“I’m not sure if this is really a serious remark, to downgrade the debt,” he said. “Everyone knows that if you buy a US Treasury bill, you can be assured you will be paid back.”

Yun said that while there are, at times, US government shutdowns or political games played, there is seldom real panic about US debt.

“Even if it is a delay of a few days or a few weeks,” he said, “everyone knows the US government will pay back the people who purchased those government bonds.”

Without this downgrade, Yun said he anticipated that mortgage rates would move lower toward the end of the year as inflation continues to cool.

Fitch Ratings, an international credit rating institution, seen in New York on April 2015.

The global bond market relies almost exclusively on three companies to issue ratings on debt.

Emphasis on companies.

While the Big Three credit-rating operations — S&P, Moody’s and Fitch — are often referred to as “agencies,” they are not government entities. They are, however, designated by US market regulators as “nationally recognized statistical rating organizations,” giving them a special status that essentially means financial firms have to follow their ratings.

Investors around the world pay these firms for their research and analysis about the quality of a bunch of different types of debt, especially government bonds, aka sovereign debt.

The same way individuals in America get a numerical credit score based on their track record of paying their bills, countries get a letter score from one of these firms based on how likely they are to pay the interest on their debt and avoid default. A triple-A rating is like having an 850 credit score — spotless. Low risk. Safe.

Of course, the Big Three are far from infallible. In the run-up to the 2008 financial crisis, all three issued overly rosy ratings on complex mortgage products that turned out to be little more than hot garbage (to borrow a technical term). And then, hot on the heels of the US subprime-mortgage crisis, European leaders accused the Big Three of accelerating the Continent’s sovereign debt crisis by being too aggressive in downgrading major economies. 

While governments have since moved to improve transparency and competition among the firms, the Big Three still control 95% of the debt-rating industry.

The Nasdaq MarketSite seen in New York, on June 9.

The Nasdaq Composite index slid roughly 2% Wednesday, leading the session’s declines.

The decline comes after the tech-heavy index was on pace to see its biggest one-day drop since February. The Dow fell 326 points, or 0.9% and the S&P 500 slipped 1.3% by mid-afternoon.

The moves come after Fitch downgraded the US’s credit rating late Tuesday after the US market had closed.

The 10-year Treasury yield remained relatively stable Wednesday after retreating from its highest level this year.

Still, some investors said stocks were due for a pullback after their run higher this year.

And despite the sell-off on Wednesday, Fitch’s downgrade could take a backseat to Wall Street’s data later this week, when companies including Apple, Amazon and Airbnb report earnings. The July labor report is also on deck.

“If earnings continue to be strong, it’s likely today will be seen as a buying opportunity in short days,” Louis Navellier, chairman of Navellier & Associates, wrote in a note on Wednesday.

Jeffrey R. Schmid, currently president and CEO of the Southwestern Graduate School of Banking Foundation at SMU’s Cox School of Business.

After a monthslong search for a new leader, the Federal Reserve Bank of Kansas City announced Wednesday its appointment of Jeffrey R. Schmid as its new president and chief executive officer.

Schmid replaces Esther George, who announced in May last year that she would be stepping down in January after reaching the mandatory retirement age of 65.

Hailing from Nebraska, Schmid officially assumes the role on August 21, just days before the Kansas City Fed’s closely watched annual symposium at Jackson Hole, Wyoming.

He’s currently the president and CEO of the Southwestern Graduate School of Banking Foundation at Southern Methodist University’s Cox School of Business.

“Jeff’s perspective as a native Nebraskan, his broad experience in banking, and his deep roots in our region will be an incredible asset to the Federal Reserve, both as a leader of the organization and in his role as a monetary policymaker,” said María Griego-Raby, deputy chair of the bank’s board of directors, who led the search for George’s successor, in a release.

The appointment illustrates how much the Federal Open Market Committee, the Fed group that determines monetary policy, has evolved in the past year. Austan Goolsbee was named president of the Chicago Fed in December 2022 and long-time St. Louis Fed President James Bullard announced he’s stepping down later this month in July.

It’s unclear whether Schmid favors a hawkish or dovish stance on addressing inflation. The Kansas City Fed president votes on monetary policy moves in 2025.

JPMorgan Chase CEO Jamie Dimon, head of the largest bank in the United States, said on Wednesday that while he doesn’t “get worried” about the state of the US economy, he’s closely watching fiscal spending, quantitative tightening and geopolitical turmoil for storm clouds ahead.

Government spending on President Joe Biden’s green economy package and military operations are incredibly high, said Dimon during an interview with CNBC from Bozeman, Montana. “Debt levels are very high,” he added, noting that the government keeps selling more of it.

Quantitative tightening, said Dimon, where the Federal Reserve sells off its assets in the open market, “could bite us at some point.”

But he said Russia’s invasion of Ukraine is what causes him the most agita.

“The humanitarian crisis in Ukraine is extraordinary,” said Dimon. Energy and food shortages caused by the conflict could cause more hardship and increase global inflation, he said.

The world is seeing “serious” levels of “nuclear proliferation and nuclear blackmail,” said Dimon. “The world’s not that safe.”

This level of geopolitical chaos, he said, hasn’t been seen since World War Two. “The world’s not that safe.”

Still, Dimon pointed out that the US consumer remains resilient and unemployment is low. If the United States does enter a recession, he said, it’s entering with strong balance sheets that will pad the impact.

Jamie Dimon, Chairman of the Board and Chief Executive Officer of JPMorgan Chase & Co., during an interview in Miami, Florida, in February.

JPMorgan Chase CEO Jamie Dimon said Wednesday Fitch’s downgrade of US debt is “ridiculous.”

“It doesn’t really matter that much,” he said during a CNBC interview from Bozeman, Montana, adding that Fitch pointed out “some issues which we all knew about.”

The markets decide how debt is rated, he added, not an agency, and “the US has the best credit in the world.”

Dimon did criticize the debt ceiling, which he said is used as a tool by both political parties to the detriment of the country. Without such a limit, he said, there would be more economic certainty.

Treasury Secretary Janet Yellen during a House Financial Services Committee hearing on June 13 in Washington, DC.

US Treasury Secretary Janet Yellen doubled down on her criticism of Fitch’s downgrade of US debt holdings in remarks Wednesday.

Yellen pointed at the US economy’s robust performance in recent months, with inflation slowing to its weakest pace since the spring of 2021 and the unemployment rate remaining historically low.

The Treasury secretary also praised political governance in the US — which Fitch cited as the main reason for its downgrade.

“Its flawed assessment is based on outdated data and fails to reflect improvements across a range of indicators, including those related to governance, that we’ve seen over the past two and a half years,” Yellen said.

“Despite the gridlock, we have seen both parties come together to pass legislation to resolve the debt limit, as well as to make historic investments in our infrastructure and American competitiveness.”

But debt-limit standoffs have become somewhat of a bargaining tool for congressional lawmakers in recent years.

While bills that Congress passed to invest in US infrastructure and the production of semiconductors had bipartisan support, other major spending packages, such as the American Rescue Plan, did not.

The downgrade points to the increasingly unsustainable nature of US sovereign debt, which can undermine the country’s ability to pay for Americans needs and wants in the years ahead.

Despite that, the United States maintains its sacrosanct reputation among investors as a nation that makes good on its financial obligations.

“At the end of the day, Fitch’s decision does not change what all of us already know: that Treasury securities remain the world’s preeminent safe and liquid asset, and that the American economy is fundamentally strong,” Yellen said.

People pass by the Treasury building in Washington, DC, on May 19.

Will Fitch’s downgrade mar the reputation of US Treasuries as the ultimate safe asset?

Probably not.

Here’s what CNN reported earlier this year:

“Any credit rating movement would be more of an embarrassment to the US than an impact to investors,” said Patrick Klein, portfolio manager at Franklin Templeton Fixed Income.

Several reasons underscore Treasuries’ pristine reputation, including that no other country has a currency market that is as liquid, large or highly rated as that of the United States.

“The US government issues something the rest of the world desperately wishes it had,” Josh Lipsky, senior director of the Atlantic Council’s GeoEconomics Center and former adviser at the International Monetary Fund, wrote in May.

The government is seen as a far more stable entity than a corporation, for instance, since it can impose taxes and take other measures to ensure it doesn’t run out of cash. That makes it an ideal issuer of debt.

Other safe assets exist but pale in comparison to Treasuries. Gold, for example, is a haven prized for its price stability even when the rest of the market experiences volatility.

But the precious metal’s prices are beholden to factors that government debt is not, including a supply that is controlled by miners. That makes the market too risky to underpin a financial system in the same way as the US Treasury market, said Olivier d’Assier, head of APAC applied research at Qontigo.

Plus, Treasuries are denominated by the US dollar, the world’s leading reserve currency — a position unlikely to be supplanted by another form of exchange such as gold, despite the value that it holds.

“It’s not like we all carry around a bunch of gold bars in our pockets to use at the grocery store,” said George Mateyo, chief investment officer at Key Private Bank.

The US Capitol building is seen in Washington, DC, on May 28.

Fitch Ratings is defending its controversial decision to downgrade the US credit rating by pointing to the nation’s mountain of debt. 

“The numbers speak for themselves,” Richard Francis, the lead analyst on US sovereign ratings at Fitch, told CNN in an interview on Wednesday. America’s debt makes up 113% (and growing) of its economic output, which Francis called “clearly pretty alarming.”

Francis, who leads the committee that decided to remove America’s perfect credit rating, expressed concern about large and growing fiscal deficits and the mounting cost to finance US debt as interest rates rise.

Within minutes of Fitch’s downgrade on Tuesday evening, the White House, Treasury Department and some leading economists slammed the move. Treasury Secretary Janet Yellen described the downgrade as “arbitrary and based on outdated data,” noting progress in many of the indicators Fitch relies on. 

Former Obama economic adviser Jason Furman called the downgrade “completely absurd” and economist Larry Summers described it as “bizarre and inept,” noting the move comes just as the US economy looks stronger than anticipated.

In response, Francis said Fitch based the decision on much broader forces than the trajectory of the economy over the next few months.

Whether America slips into a mild recession or narrowly avoids one “just doesn’t move the needle,” Francis told CNN. 

Read more here.

Traders work on the floor at the New York Stock Exchange on July 26.

The Dow fell by nearly 230 points, or 0.6%, in midday trading as investor sentiment continued to be weighed down by Fitch’s downgrade of US long-term debt.

The S&P 500 was down by 1.3% and the Nasdaq composite dropped 2.4%.

The 10-Year Treasury yield reached its highest level since November, at around 4.1%.

Tech stocks led the downward spiral as titans like Amazon, Microsoft, Tesla, Nvidia and Meta were all trading more than 2% lower.

The end of a robust earnings season is also underway.

CVS gained 3.8% after beating estimates and Kraft Heinz grew by more than 1.4% even after reporting that higher prices were limiting consumer demand.

Chinese stocks, meanwhile, dropped after officials in Beijing proposed limits on smartphone use for minors. Shares of JD.com, Alibaba and Baidu were all down about 5% on the news.

A pedestrian walks past an electronic billboard displaying the current U.S. national debt on July 6 in Washington, DC. 

Tuesday evening brought a flurry of chaos to newsrooms across America as rating agency Fitch downgraded long-term US debt from AAA to AA+ … at nearly the exact moment former president Donald Trump was indicted on four criminal charges by a federal grand jury in special counsel Jack Smith’s investigation into efforts to overturn the 2020 election.

So why did two major US news events happen simultaneously?

This is a classic example of correlation, not causation.

Fitch first put the United States’ perfect rating on watch in May as the debt ceiling fight raged on but, in reality, this downgrade is two decades in the making, the agency said Tuesday.

“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,” Fitch said in its explanation.

Still, Treasury Secretary Janet Yellen called the timing of the change “arbitrary” on Tuesday. Fitch’s models, she said, showed that US governance on the debt ceiling was also deteriorating between 2018 and 2020 but no changes were made then.

Former Treasury Secretary Larry Summers also called the timing of the change into question.

“The United States faces serious long-run fiscal challenges. But the decision of a credit rating agency today, as the economy looks stronger than expected, to downgrade the United States is bizarre and inept,” he said on Twitter, now formally known as X.

Still, the US Treasury said on Monday that it will need to borrow another $1 trillion to fund the growing budget deficit, which is up 170% since last year. In May, the Treasury estimated it would need to borrow $733 billion.

In a note, the Treasury added that “further gradual increases will likely be necessary in future quarters.”

The sudden increase in borrowing took investors by surprise this week and could have raised eyebrows at Fitch.

The correlation aspect is also fairly strong.

Richard Francis, a senior director at Fitch Ratings, told CNN Wednesday that while the timing turned out to be fitting, given Fitch’s concerns about the state of governance in America, the exact timing was “purely a coincidence,” noting that the Fitch committee made the decision to downgrade the day before.

For only the second time in US history, a credit rating firm downgraded its assessment of American long-term debt from a pristine AAA to AA+, one notch below. 

What’s with the alphabet soup?

In short, the letters assigned by credit rating firms are just shorthand to signal to investors how safe or risky they view a certain debt instrument to be. In this case, the debt is United States’ long-term sovereign bonds.

Each of the Big Three credit rating operations — S&P, Moody’s and Fitch — uses a slightly different scale, but all of them start with AAA at the top.

AAA is the safest bet. It tells investors around the world that the issuer of the debt (i.e., the United States government) is practically guaranteed to make interest payments on time and not default.

Up until 2011, the United States had a perfect rating from all three firms. S&P was the first to downgrade it over a debt-ceiling standoff. Fitch became the second on Tuesday, when it cited DC dysfunction and yet another debt-ceiling debacle just weeks earlier. (Even though the US didn’t default in either case, the mere specter of default was enough to make investors nervous.)

The difference between AAA and AA+ is minimal.

Under Fitch’s system, AAA is defined as the “lowest expectation of default risk,” while AA+ signals “expectations of a very low level of default risk.” To put in public-school grading terms: AAA is the valedictorian who took honors and AP and did all the extra credit. AA+ is just a run-of-the-mill nerd with perfect grades.

The exterior of the U.S. Department of Treasury building is seen on March 13 in Washington, DC.

The US government bond market should remain unshakeable despite credit rating agency Fitch’s sovereign debt downgrade, said Chris Rupkey, chief economist at FwdBonds.

“We don’t know if the ratings agency wants publicity or whether they have some ‘too much government spending’ deficit hawks in their management at the tippy top,” Rupkey wrote in commentary issued Wednesday. “The US government securities market is too big to fail, and bond investors at least shrugged at the news.”

Separately, he noted, the latest labor market activity data is further fueling optimism that a soft landing could be in store for the US economy.

Payroll processor ADP reported earlier Wednesday that private employers added 324,000 jobs in July, a stronger-than-expected number that shows the labor market remains quite robust in the face of a barrage of interest rate hikes.

“The labor market is firing on all cylinders this summer,” Rupkey wrote. “This is the latest in soft-landing economic statistics where Fed officials are seeing inflation slowing down without creating the massive unemployment seen in a recession.”

And as long as inflation continues its cooling trend, that will likely set the stage for a Fed pause when central bank policymakers meet in September, he said.

“Stay tuned; story developing,” he added.

Pedestrians walk outside the U.S. Capitol on March 21 in Washington, DC.

Markets may have had a tepid response to Fitch’s downgrade of the US sovereign debt but the rating agency’s message is “stark,” said Quincy Krosby, Chief Global Strategist for LPL Financial, in a note issued Wednesday.

Mostly, the downgrade is an acknowledgement that the US budget deficit “has to be quelled,” she said. 

“Ultimately, if the deficit isn’t contained, taxes will be raised to the point that the engine of the US economy, the all-important consumer, will have considerably less discretionary income,” Krosby said.

While markets are focusing today on the 10-year Treasury note, the growing deficit is “a much more enduring concern than just today’s market action and Fitch’s downgrade,” she said.

Traders work the floor of the New York Stock Exchange on July 25.

US markets opened lower on Wednesday following the downgrade of long-term US credit by rating agency Fitch.

The Dow was down 155 points, or 0.4%. The S&P 500 slid 0.8% and the Nasdaq Composite fell by 1.1%.

Treasury yields, meanwhile, remained relatively calm. There was also little change in the US dollar.

Fitch Ratings downgraded US long-term debt late on Tuesday from AAA to AA+, citing this spring’s debt ceiling standoff as a major reason.

While the move is a blow to the US, analysts aren’t sure that it will move markets significantly lower. “We question if the downgrade will matter,” wrote Jaret Seiberg, an analyst at TD Cowen, in a note. “This will not impact how much capital banks must hold against Treasury securities or agency debt.”

Traders, meanwhile, continued to digest a slew of second-quarter earnings reports on Wednesday morning.

Shares of online dating stock Match Group soared by about 5.2% after the parent company of Tinder and Hinge reported better-than-expected earnings and stronger forward guidance.

SolarEdge Technologies fell by more than 16% after missing on revenue expectations.

Shares of CVS were also trading about 1% lower, even after beating on earnings and revenue. The company announced earlier this week that it would lay off 5,000 employees as part of a cost-cutting plan.

In economic news, private sector companies added more jobs than expected in July, according to ADP. About 324,000 jobs were added last month. Analysts had forecast that number would be closer to 189,000. In today’s good-news-is-bad-news economy, that could mean the Federal Reserve has more incentive to raise interest rates at its next meeting in September.

The surprising resilience of the US economy has forced Bank of America to abandon its forecast for a mild recession and join a growing group of banks calling for a soft landing.

In a note to clients on Wednesday, Bank of America economists revealed they now expect growth to stay positive over the coming quarters and the unemployment rate to rise more gradually. 

“Our revisions imply we no longer expect a mild recession and, instead, think the economy may be able to skirt one,” Bank of America economists led by Michael Gapen wrote in the report. 

Bank of America cited persistent US GDP growth, the near record low unemployment rate and cooling inflation and wage growth. 

The bank upgraded its 2023 GDP forecast to 2%, compared with 1.5% previously. It now sees 0.7% GDP growth next year, an upgrade from a prior call for no growth.

It’s a significant reversal for a bank that last fall warned the US economy would lose tens of thousands of jobs a month in early 2023. As recently as late last month Bank of America CEO Brian Moynihan told CNN’s Poppy Harlow a “mild” recession was likely in the cards early next year. 

But resilient consumer spending and hiring, combined with cooling inflation, have prompted a series of economists to either delay their recession calls or scrap them altogether. 

Bank of America now expects the unemployment rate to peak at 4.3% in early 2025. That’s up from 3.6% today but below the bank’s previous forecast for a peak of 4.7%. 

However, Bank of America cautions that a downturn is still a real risk, assigning a 35%-40% chance of a mild recession. 

“The economy is not entirely out of the woods yet and a mild recession remains our second most likely outcome,” Bank of America economists wrote. 

The US Treasury Department in Washington, DC, on May 8.

Huh.

Conventional wisdom was thrown out the window Wednesday, after Fitch downgraded America’s debt rating, and US government debt yields fell.

You’d expect the opposite to be true. Fitch effectively said Tuesday night that America is a less safe place to invest, which typically would mean the US Treasury would have to pay more to finance its debt. That would come in the form of higher Treasury yields — i.e. the amount the government pays debt holders to borrow money.

Instead, Treasury yields did basically nothing Wednesday. The 10-year yield was last up a measly 0.048 percentage points to 4.094%. Other bond yields were similarly up or down just hundredths or thousandths of a percentage point.

So what’s going on?

Some market analysts say the consequences of the debt-ceiling standoff and political dysfunction have largely been priced in already — and stocks are off to their best start to a year since 1997, so investors are obviously giddy. Others said the downgrade’s timing is odd, because the US economy remains strong, even in the wake of all that political squabbling.

But it probably comes down to this: Where else are you going to put your money? When the going gets tough, American debt remains the safest investment in the world. And with Europe emerging from a recession and China’s economy in turmoil, America’s debt is looking mighty strong at the moment.

People walk past the New York Stock Exchange on Wall Street on August 1 in New York City.

Stock futures slid on Wednesday morning and Treasury yields pulled back slightly after rating agency Fitch downgraded US long-term credit and investors digested the latest batch of second-quarter earnings reports.

Ahead of the bell, the Dow was down 125 points, or 0.4%. The S&P 500 slid 0.5% and the Nasdaq Composite fell by 0.8%.

The downgrade comes in the thick of earnings season: CVS, Taco Bell owner Yum! Brands and Kraft Heinz all reported on Wednesday morning.

CVS was trading about 1.7% higher in early trading after beating earnings estimates and announcing cost-slashing measures. The company said Tuesday it would lay off 5,000 employees as it focuses more deeply on its health care offerings.

Yum! Brands dropped by about 1% after missing on revenue estimates.

Kraft Heinz dropped 0.6% after the company said higher prices were taking a bite out of consumer demand.

In economic news, private sector companies in the United States added 324,000 jobs in July, according to payroll processor ADP’s monthly employment report released Wednesday. That blows past economists’ estimates of 189,000 jobs.

Job seekers speak with recruiters during a job fair at Navy Pier on April 11 in Chicago, Illinois. 

Private sector companies in the United States added 324,000 jobs in July, according to payroll processor ADP’s monthly employment report released Wednesday.

Economists were expecting a net gain of 189,000 private-sector jobs, according to consensus estimates on Refinitiv.

Leisure and hospitality hiring bolstered the hotter-than-expected July job gains, accounting for 201,000 of the monthly hires, according to the ADP National Employment Report. Most other major sectors showed job gains, with financial activities and manufacturing reporting losses, according to the report.

“The economy is doing better than expected, and a healthy labor market continues to support household spending,” Nela Richardson, ADP’s chief economist, said in a statement. “We continue to see a slowdown in pay growth without broad-based job loss.”

While the ADP report is sometimes viewed as a proxy for overall hiring activity, it doesn’t always correlate with the government’s monthly jobs report.

In June, ADP reported that the private sector added 497,000 jobs, a blockbuster jump that defied expectations and came in far toastier than the official federal jobs report for the month. The Bureau of Labor Statistics reported that US employers added 209,000 jobs in June, with the private sector contributing 120,000 of those net gains.

The BLS is set to release its July jobs report at 8:30 a.m. ET Friday.