There are some big themes that are driving financial markets right now. The biggest one that is dominating this week is the US credit downgrade. As we mentioned earlier, we think that this will only have a temporary impact on financial markets, since Moody’s was the last rating agency to hold onto a triple A credit rating for the US. US stocks are losing ground at the US open, led by Big Tech. Nvidia is down by less than 1% so far, which could be used as a buying opportunity, since the credit rating downgrade for the US is unlikely to impact their revenues any time soon. Tesla is down 3% and Apple is down 2%. The bigger impact is in the bond market, with a sharp daily increase in US bond yields.
Why US stocks are vulnerable to changes in sentiment
If the US economy is unlikely to be dramatically impacted by the credit rating downgrade at this stage, then why are stocks selling off? Part of the reason is the steepening of the US Treasury curve, and the fact that yields are rising as the dollar is falling. This could make borrowing more expensive for consumers and for businesses. The second reason is the drivers of the stock market rally in the last month. Momentum and growth have been the biggest factors driving the S&P 500 higher, which leaves the US index vulnerable to a sudden change of sentiment like we have seen today.
Overall, we do not think that this downgrade is going to change anything fundamental about the US’s fiscal position, so the information is irrelevant. The US Budget is likely to increase the deficit, which was flagged back in November before the election. If the market did not react then, it is unlikely to react now. Also, a wave of corporate tax cuts could boost profitability at some firms, which is good news for stock prices.
US fiscal concerns contained for now
The 30-year US Treasury yield is oscillating around the 5% rate, if the long end yield does not surge much above this level, then we think that US fiscal concerns can be contained for now. This week’s 10-year Tips auction and 20-year Treasury bond auction will be worth watching to test the water and see what demand is like as the US’s debt trajectory takes center stage.
The other big theme that is dominating markets is the UK/EU deal to strengthen post Brexit relations. This will immediately help cut red tape for food and drink exports; it will boost energy cooperation and it paves the way for future economic cooperation. The market impact has been mild so far. Global bond yields are rising in unison, and European bond yields are also higher today, along with US yields. However, this deal is good news for the UK. The limited deal that was agreed this weekend could add another £10bn to the UK’s economy over the next 15 years. Combined with the Indian trade deal and the US trade agreement, the UK economy could be boosted to the tune of £5bn.
UK stocks may have delayed reaction to UK/ EU re set deal
Defense also received a boost; the EU and the UK will work towards allowing UK defense firms access to the EU’s joint procurement defense funds. The impact on UK defense stocks has been minimal so far, as the global sell off weighs on UK markets. Going forward, freedom of movement for EU and UK citizens will be discussed. However, conspicuous by its absence was any mention of the financial sector. Brexit has led to some relocation of operations and assets away from the UK, and closer relations with the EU could halt this trend. Although London is still a major financial hub, weak growth has been blamed for a dearth of IPOs on the London market in recent years. If the UK can revive relations with its nearest trading partner, and boost the UK’s position in the EU, a market of more than 400mn people, then that should be good for growth, it will also have many benefits for the UK economy, including the financial sector.
The impact on UK asset prices
The euro and the pound are stronger vs. the USD on Monday; however, this is mostly down to a broad-based weakening of the dollar, which is under pressure as bond yields rise and fiscal concerns dominate the market narrative at the start of this week. However, we think that this re-set between the UK and the EU is a game changer, especially for the UK, and we could see UK asset prices recover quickly. We will be watching to see if the FTSE 100 can rise back towards the records high of 8,900 from March. GBP/USD could also be a beneficiary and may move to fresh highs for 2025 around $1.35.
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