2025.05.19 Weekly
Ratings downgrade is just noise
Skipping the usual medley of market charts today and just noting my thoughts on the latest US debt downgrade and economic data.
It’s rare that I find myself struggling to find a reason to move-on from my view, but as I focus on what could move me to change, I consider rising yields the biggest risk — particularly in the context of the US budget deficit and the “Big Beautiful Bill” that is projected to add 1.9 trillion a year to the running debt balance of 36 trillion. This has prompted Moody’s to follow Fitch and S&P on downgrading US debt off the top triple-A rating to reflect “the increase over more than a decade in government debt and interest payment ratios to levels that are significantly higher than similarly rated sovereigns” (full report).
“Successive US administrations and Congress have failed to agree on measures to reverse the trend of large annual fiscal deficits and growing interest costs. We do not believe that material multi-year reductions in mandatory spending and deficits will result from current fiscal proposals under consideration. Over the next decade, we expect larger deficits as entitlement spending rises while government revenue remains broadly flat. In turn, persistent, large fiscal deficits will drive the government’s debt and interest burden higher.”
“Despite high demand for US Treasury assets, higher Treasury yields since 2021 have contributed to a decline in debt affordability. Federal interest payments are likely to absorb around 30% of revenue by 2035, up from about 18% in 2024 and 9% in 2021. The US general government interest burden, which takes into account federal, state and local debt, absorbed 12% of revenue in 2024, compared to 1.6% for Aaa-rated sovereigns. While we recognize the US’ significant economic and financial strengths, we believe these no longer fully counterbalance the decline in fiscal metrics.”
That’s some serious stuff that could see rates volatility coming back, add another 25bps in credit and term premiums to bond yields, and exert some downward pressure on equities due to its impact on valuations. But first, I’ll argue that it isn’t anything particularly new, and second, that it probably won’t affect markets any time soon.
The “sell America” theme has already been in full swing — fiscal policies as well as trade, was already one of the major drivers behind the bond sell off alongside the dollar resulting in the us yields/dollar correlation to break (chart: USD G10 index vs 10yr yield), and the expectation of a Moody’s downgrade has been in the works since they downshifted their outlook last year. And with Bond vigilantes already pricing the impact of the new bill, this downgrade shouldn’t come as a surprise to markets. To whether the “sell America” theme could have legs, possibly. But I don’t think it will be anything as spectacular as we saw in April. Growth expectations turned more optimistic as a result of the massive trade deescalation with China, and a big part of the yield curve shifting higher was down to the repricing at the front-end of the curve from as much as 5 to now 2 cuts expected for this year.
So as long as inflation continues to soften like it is now, and growth expectations continue to improve as new trade arrangements are being made, the sell America theme is far less obvious that it was a just over a month ago. While I note higher bond yields to be the biggest risk for markets, assuming bond markets have been adequately pricing-in the fiscal debt situation which has been building since the pandemic, I think these issues will be in the background to tariff rollbacks and improving outlook continuing to be the dominant narrative for equities.
If we do continue to see a sell America theme play out in markets, it will probably be via USD where I’m more neutral on USD as a result (e.g. still positive USDJPY USDCHF, but slightly bearish USD versus cyclical currencies), which makes me favour non-USD pairings such as long AUDJPY and EURCHF for example.
DATA REVIEW
Lots of data in last week pointing further in the direction of hard data goldilocks (monderating inflation and activity) and soft data uncertainty weighing business and consumer confidence.
CPI was 0.2% in April, below the 0.3% expected mostly due to the -0.1% in Food prices after a +0.4% acceleration in March. Core CPI continues to ease off the January peak with the 3-month annualised rate almost 200bps lower since the beginning of the year.
Producer prices unexpectedly fell as wholesale services prices dropped -0.7%, the largest decline since the government started tracking the series in December 2009.
Prices for hotel and motel rooms dropped 3.1% after easing 0.5% in March. Key core-PCE components Portfolio management plunged -6.9%, and Airline fares -1.5%.
Retail sales slowed after the front-loaded spending surge in March ahead of tariffs. A 0.1% m/m increase for April still highlights strong consumer spending however with the 3month annualised rates going to new peaks for the year.
Initial claims held steady with the non-seasonally adjusted figure continuing to ease off.
UoM consumer confidence fell further though the pace has slowed considerably while the various measures are around level seen during the last slowdown/recession-concerned bear market in 2022.
Inflation expectations surged further, the 1-year reaching 7.3% from 6.5% the prior month which “was seen among Democrats and Republicans alike” according to the survey report. “Long-run inflation expectations lifted from 4.4% in April to 4.6% in May, reflecting a particularly large monthly jump among Republicans. The final release for May will reveal the extent to which the May 12 pause on some China tariffs leads consumers to update their expectations.”
Small Business Optimism decreased at a slower rate. Aside the uncertainties on outlook and expectations, actual earnings and actual sales continued to increase.
Employment increased as openings have been reduced/filled. Other metrics continue to point further in the direction of labour market loosening.
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Good luck trading.
