We saw a small spike in equity market volatility this week, but for once the predominant driver wasn’t central banks. Instead, the credit (pardon the pun) goes to Fitch, the rating agency, who took the surprise decision to downgrade the credit rating of US federal government debt from the much coveted AAA rating to AA+. The move took the market by surprise, as it is not as if the negative news around the US public finances is new news, with many of the challenges facing such already well known.

The equity markets initial reaction to the news was negative. However, from an institutional investors point of view, the downgrade from a regulatory perspective makes no difference when it comes to investing in US Treasuries. In terms of any risk weightings which may have been applied, the Bank for International Settlements apply no weighting to bonds rated between AAA and AA-. The write down is therefore of no consequence to commercial banks, subject to any internal rules which they may have.

Another large investor group would be pension schemes and insurance companies, who purchase Treasuries as liability matching assets. Here the change in rating is again likely to have little impact. Finally, we have those who hold foreign exchange reserves in US dollars. As we know, a lot of global trade and transactions are conducted in this currency. When you have surplus therefore, a home is needed. We see this rating change as having little consequence to this home remaining Treasuries. So, was the rating change simply an excuse to take some of the recently made profit off the table?

In terms of US economic data, the picture remains mixed. The ISM Purchasing Managers Index (PMI) for manufacturing remains in contraction territory, again posting a figure below the magic 50 level. ISM reported that demand remained weak, production continues to slow, new orders reduced and therefore capacity remains. Conversely, the ISM data for services remained in expansion territory, although below the consensus forecast. At the time of writing we await the US non-farm payroll numbers. The JOLTs Job Opening figures released this week suggest that there may be some softness appearing in the labour market, but more consistent data over time will be needed to confirm this.

In the UK the Bank of England made their 14th consecutive increase in interest rates, lifting by 0.25% to 5.25%. The voting was rather mixed this time however, with six members of the committee voting in favour of a 0.25% hike, whilst two voted for 0.5% and one voted for no change. This perhaps reflects the uncertainty over future inflation prints and also the difficulty in trying to interpret what impact past hikes have already had and what is still left to work through the economy. They now also forecast that inflation will fall quicker than they forecast in May, reaching 5% by the end of this year.

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