U.S. Debt Downgrade Mostly met with Resilience…

Week In Review – August 4, 2023

U.S. Debt Downgrade Mostly met with Resilience

On August 1, Fitch Ratings, a credit rating agency, downgraded the credit rating of U.S. Government debt one notch, from ‘AAA’ to ‘AA+.’ The rating agency had warned that it might make this step several months ago during the U.S. debt ceiling standoff.

The timing of this credit downgrade is unusual given the lack of near-term concerns with the debt ceiling and the recent strong numbers around U.S. economic growth. The rationale given was longer-term concern about the plan for managing U.S. Government debt in a higher interest rate environment. As well as the ever-escalating demands to support core programs such as social security and healthcare.

The Fitch Ratings action echoes the S&P’s decision in August 2011 to downgrade the U.S. to ‘AA+’ amid a debt ceiling standoff. At that time, U.S. stocks initially sold off but recovered very quickly, and U.S. Treasury bonds rallied on a flight-to-quality trade. In this week’s markets, Treasury yields were initially unchanged on the downgrade announcement but then ticked higher later in the session sending fixed-income markets down. Equity markets also dropped following the downgrade. However, the actual cause of the market reaction is unclear as it came alongside headlines on larger-than-expected upcoming Treasury actions and continued strength in the U.S. labor market and recent new highs in the equity market.

This latest action by Fitch is likely to increase longer-term concerns about the demand for Treasury securities and weigh on the longer-term end of the bond market. The benchmark 10-year treasury is back to levels that have not been seen in the past 15 years and are on par with the peak seen during last fall.

While off the historical sentiment low of June 2022, consumer sentiment remains well below historical standards. This is important because two-thirds of the U.S. economy is driven by consumer spending. Stubbornly low consumer sentiment suggests a high level of uncertainty about the future remains in the mind of the consumer. As the Federal Reserve continues to tighten financial conditions to bring down inflation, and consumer sentiment remains tepid, risks for a slowdown in the economy remain, potentially curbing the recent market recovery. Consumer sentiment and Federal Reserve policy notwithstanding, the likelihood of a deep recession is arguably feared less than it was a year ago.

The near-term market and investment implications for higher rates will be headwinds. A run higher in the bond markets will likely put pressure on fixed income returns which move inversely with yields. For the equity markets, higher rates may limit further multiple expansion which has been the primary driver of returns year-to-date. Offsetting the investment market headwinds will be prospects of lower inflation, continued resilience of the U.S. economy, and relative safety of U.S. investment on the world stage.

Important Disclosure:

The information contained herein is for informational purposes only, is not personalized investment advice and should not be construed as a recommendation to purchase or sell any particular security, sector or strategy to any individual person or entity. The decision to review or consider the purchase or sale of any security, sector or strategy mentioned should not be undertaken without consideration of your personal financial information, investment objectives and risk tolerance with your financial professional. Past performance should not be considered as an indicator of future results. Investment Advice offered through Pallas Capital Advisors LLC, a registered investment advisor.

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Mark-Bogar

Mark A. Bogar, CFA®, CAIA®
Chief Investment Officer
Pallas Capital Advisors

Stephen Kylander

Stephen Kylander
Senior Portfolio Manager
Pallas Capital Advisors

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The information contained herein is for informational purposes only, is not personalized investment advice and should not be construed as a recommendation to purchase or sell any particular security, sector or strategy to any individual person or entity. The decision to review or consider the purchase or sale of any security, sector or strategy mentioned should not be undertaken without consideration of your personal financial information, investment objectives and risk tolerance with your financial professional. Past performance should not be considered as an indicator of future results.

Investment Advice offered through Pallas Capital Advisors LLC, a registered investment advisor.

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