FITCH DOWNGRADE OF USA LEAVES MARKETS UNCERTAIN

Finally, and as predicted by Private Office Asset Management Limited during the Spring of this year, this week we saw the US Debt mountain come home to roost when the United States government’s credit rating was downgraded by one of the ”Big 3” credit rating agencies ‘Fitch’. Fitch Ratings Inc. is an American Credit rating Agency! The US debt continues to mount under the Biden administration, partly due to spending on the green economy and the war in Ukraine, but as much as anything because that is just the way it is with the US these days.  No matter how good or bad the economic outlook is, and irrespective of the tax revenue of the worldwide clutches of its aggressive Internal revenue Service (IRS), they just seem to perpetually be increasing their debt levels.

We wrote an article on this 4 months ago when we pointed out that you could take the US debt mountain and put it on a payload on the fastest rocket ever built by man, and send it full blast to our nearest star system Alpha Centauri which is 4.5 light years away.  Light travels at 187,000 miles per second (£1Million miles every 5.5 seconds, and light takes 4.6 years to travel between mother earth and Alpha Centauri – and it would take the Saturn V rocket going full blast with no air resistance in the vacuum of space fully 100,000 years to get reach Alpha Centauri.  It is a distance so vast that cosmologists do not use “miles” as a measure of distance, they use 2 light years”.  And unfathomably far away as it is – you could drop US$1 for every single mile traveled during that 100,000 year journey, and you would still have enough of the US Dollars in tow do drop US$1 for every single mile up to 18% of the 30,000,000,000,000 mile journey back to our beautiful earth.

The US Debt is absolutely staggering, all the more so when you consider that the US is purportedly the richest nation on earth. Well, the US does have some of the instantly recognisable, glamorous, household name  who are the richest individuals on the planet, and the glamourous Hollywood set, the famous Wall Street and all of the US propaganda that still clings onto the so-called ‘American dream’.  But then it also has some of the deepest, and increasing, unseen poverty amongst its citizens that we hear much less about. We believe this downgrade is absolutely deserved and the right thing for Fitch to have done, despite the obvious protestations for Janet Yellen and he colleagues whose job it is to talk up the strength of the US economy.  The US in our opinion needs a kick up the proverbial behind in relation to its debt.

As a result of the downgrade, bond markets have been moving this week with yields on developed market government bonds rising again (which means that the value of these assets have fallen). But while yields seem to be rising in unison, there is a lot going on underneath the surface as economies show more signs of diverging, and levels of government debt have a say in this divergence.

Meanwhile, the Bank of England continued its ‘oh-so-predictable’ and blunt inflation tightening campaign which hurts the majority of people who are struggling, – but not so much the well off including the policymakers who are behind yet another 0.25% rate hike.  The Bank of England’s chief economist, Huw Pill, admitted that the Bank of England risks raising interest rates too far in its attempt to get inflation back under control [having made such a pigs-ear of allowing inflation to gallop away in the first place]. Pill has conceded that “it is possible that we do too much” to rein in price rises as analysts warned that over-tightening would push the country into an “unnecessary recession”, he said speaking to businesses the day after the Bank’s Monetary Policy Committee (MPC) raised interest rates to 5.25%.

The UK’s rate hike was accompanied by warnings that rates will be higher for longer and wage inflation remains a crucial factor in future decisions. In the EU, growth remains weak and inflation remains sticky. In the US, strong jobs data means rates may have further to go and the government said it will significantly increase bond issuance. The sovereign downgrade may not be worth worrying over but bond markets are finding other things to be concerned about.

 

UK : BANK OF ENGLAND OPTS FOR SMALL RATE HIKE OVER FEARS OF CAUSING RECESSION

The Bank of England has increased interest rates to the highest level in 15 years as it confirmed a 0.25% hike. The UK has continued to close the gap on the US as the Bank of England chose to increase at the 14th consecutive interest rate meeting to take the bank’s base rate to 5.25%. Following recent strong employment and inflation data, some investors were expecting a larger increase of 0.5% and the smaller hike caused the pound to fall against the dollar and euro and gilt yields have risen steadily.

Investor attention will now turn to the outlook for rates. Markets now forecast that UK interest rates will peak at 5.75% in the second half of the year. Recent data shows inflation is falling steadily and the Consumer Price Index dropped to 7.9% last month, from a peak of 11% in October. The Bank of England now predicts inflation will fall below 5% this year. However, Bank of England governor Andrew Bailey said he expects rates to remain high for some time and indicated that further hikes may be required if wage inflation remains too high.

 

US : BOND MARKET UNMOVED BY RATING DOWNGRADE

Ratings agency Fitch unexpectedly (but quite correctly in our opinion) cut the credit rating of the US government from AAA to AA+ following the political stand-off over increasing the US debt ceiling back in June caused in part by the government’s spending on the transition to a lower carbon economy and the war in Ukraine. The news generated a lot of commentary about what this may mean for US government borrowing. Equity markets were unsettled, and the knock on effect for US government bonds is that the borrowing costs of the colossal amount of debt that it carries, could now increase. Bond yields have risen this week on both sides of the Atlantic. Surprisingly strong jobs data later in the week had a greater impact as a strong jobs market has the potential to cause the US Federal Reserve to keep hiking rates.

In contrast to the fairly robust economic data in the US, the latest GDP update for the EU showed economic growth remains weak. GDP for the EU increased by 0.3% in the second quarter. This is an improvement on the previous quarter when there was no growth reported, but it is considerably below the 2.4% annualised growth for the US over the same period.

UK : HOUSE PRICES FALLING AT FASTEST RATE SINCE 2008

UK house prices are falling at the fastest rate since the so called financial crisis of 2008/09. According to the latest figures from Nationwide building society, property prices fell by 3.8% over the 12 months to the end July as higher mortgage borrowing costs deter some buyers. The cost of the average 2-year fixed mortgage has increased from 2.8% at the end of July 2022 to 6.85% this week, although several lenders have reduced rates slightly in the last few days. However, anecdotally house prices appear to be falling further than that as sellers become more realistic creating a “buyers market”.

Although the increased cost of borrowing is a major contributor to the slowdown in house building, buyers are not entirely put off as they hope for some bargain prices from desperate sellers. Builders merchant, Travis Perkins, said profits are down 31% as the number of homes under construction has dropped from 52,000 in the second quarter of 2022 to less than 38,000 in the first quarter of this year. Meanwhile, house builder Taylor Wimpey reported sales below last year’s level but said there is still a strong underlying interest as buyers are taking on longer fixed-rate mortgages to deal with higher costs.

Please note that the opinions expressed in this newsletter are those of the author, and they do not purport to reflect the opinions or views of Private Office Asset Management and should not be construed as advice.

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