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US stocks had their biggest one-day drop in months, joining a global sell-off, as a surprise downgrade of the country’s debt rating and stronger than expected jobs data raised concerns over the possibility of an extended period of higher interest rates that weigh on risky assets.
Wall Street’s benchmark S&P 500 fell 1.4 per cent on Wednesday, its biggest daily drop since late April, while the tech-focused Nasdaq Composite gave up 2.2 per cent in its largest daily drop since February.
Late on Tuesday Fitch cut its US credit rating from triple A to double A plus, citing a mounting government debt burden and the debt ceiling stand-off that two months ago brought the world’s largest economy close to a default.
Fitch signalled in May that a downgrade was possible and few analysts expected big market shifts as a result. Still, it was only the second such warning from a big rating agency after Standard & Poor’s rocked financial markets with a similar move in 2011, which was also associated with a tense debt ceiling fight.
“The difference with the S&P 2011 move was that back then yields fell as investors sought the safety of US bonds and the dollar, and now they’re rising. That could be the key piece of all this,” said Michael Arone, chief investment strategist for State Street Global Advisors.
Rising yields can be a sign that investors perceive greater risk.
The US narrowly avoided a government default in June, with the federal borrowing limit lifted at the eleventh hour following months of tensions over spending cuts.
Combined with news that the US Treasury planned to increase the size of its bond sales to help cover the deficit, Fitch’s move was enough to push yields on 10-year Treasuries up to almost 4.13 per cent — their highest since early November. They pulled back to about 4.07 per cent, leaving them slightly higher for the session. Bond prices fall as yields rise.
“When the 10-year yield was above 4 per cent back in the [autumn] of last year, the stock market was 20 per cent lower,” said Matt Maley, chief market strategist at Miller Tabak + Co. “Therefore, it’s going to be very tough for this expensive stock market to keep rallying in the same way it has so far this year.”
While Wednesday’s move in Treasuries was not large, it helped consolidate yields above 4 per cent — an important level for market watchers since the 10-year benchmark has failed to hold above that level for an extended period since 2007.
The dollar held firm, however, rising 0.3 per cent on the day.
“The firming in the dollar index pretty much says it all,” wrote analysts at Action Economics. “The US is still the cleanest dirty shirt in the hamper and that is limiting the negative fallout.”
Also on Wednesday, new data suggested that the US labour market is still tight despite elevated interest rates. The ADP national employment survey showed that private sector employment increased by 324,000 jobs in July, well above analysts’ expectations for 189,000.
“That’s the news that cause yields to move higher,” Maley said. “It raises the odds that rates will remain higher for longer . . . even if the Fed stops raising rates soon.”
The stronger figures support the view that the US economy may be on track to achieve a “soft landing”, but the shrinking probability of a slowdown or recession means interest rates may not quickly drop back to low levels.
Investors will get more perspective on the labour market on Friday, when non-farm payrolls data is released.
Wall Street’s sell-off followed similar weakness in Europe, where the Stoxx Europe 600 index closed 1.4 per cent lower. In Asia, Hong Kong’s Hang Seng index dropped 2.5 per cent, and Japan’s Topix fell 1.5 per cent.
London’s FTSE 100 ended down 1.4 per cent, a day before the Bank of England is expected to increase its benchmark bank rate to 5.25 per cent.