Stocks sink after historic US credit rating downgrade

US markets fell in Wednesday trading following the downgrade of US debt from the highest AAA rating to AA+ by rating company Fitch.

Fitch cited "a steady deterioration in standards of governance" as a major reason behind its decision on Tuesday evening.

A major sell-off, led by the technology sector, followed.

The Dow closed 348 points, or 1%, lower in Wednesday trading. The S&P 500 fell 1.4% and the Nasdaq dropped 2.2%, marking its worst performance since February.

The 10-year Treasury yield hit its highest level since November. Bond prices and yields move in opposite directions, so falling Treasuries boost yields.

Tech megacap stocks like Amazon, Meta, Microsoft, Tesla, Nvidia and Apple led market declines. Because the tech sector is so forward-facing, it’s particularly sensitive to interest rate changes.

Earnings season, meanwhile, is more than halfway through. About 82% of S&P 500 companies have beaten expectations, according to FactSet data.

CVS was up nearly 3.3% after beating earnings expectations Wednesday morning.

Kraft Heinz, meanwhile, also rose more than 1.2% even after reporting that higher prices had led to a slowdown in consumer demand.

Shopify, PayPal, Occidental Petroleum, MetLife, DoorDash, Clorox, MGM Resorts, Marathon Oil, Zillow, Etsy and Robinhood report earnings after market close.

August is a historically bad month for markets because so many investors take vacations and there are decreased trading volumes. This reduced activity can lead to increased volatility.

Mortgage rates rose Wednesday, following Fitch's downgrade of US debt.

The yield on 10-year Treasuries climbed as high as it had been since November. The fixed rate for a 30-year mortgage tends to follow the yield on the 10-year Treasury note.

"What is happening related to the downgrade of the US debt has really bumped up some of the borrowing costs," said Lawrence Yun, chief economist at the National Association of Realtors, during a previously scheduled economic summit hosted by NAR.

But Yun questioned how seriously to take the announcement.

"I'm not sure if this is really a serious remark, to downgrade the debt," he said. "Everyone knows that if you buy a US Treasury bill, you can be assured you will be paid back."

Yun said that while there are, at times, US government shutdowns or political games played, there is seldom real panic about US debt.

"Even if it is a delay of a few days or a few weeks," he said, "everyone knows the US government will pay back the people who purchased those government bonds."

Without this downgrade, Yun said he anticipated that mortgage rates would move lower toward the end of the year as inflation continues to cool.

The global bond market relies almost exclusively on three companies to issue ratings on debt.

Emphasis on companies.

While the Big Three credit-rating operations — S&P, Moody’s and Fitch — are often referred to as “agencies,” they are not government entities. They are, however, designated by US market regulators as “nationally recognized statistical rating organizations,” giving them a special status that essentially means financial firms have to follow their ratings.

Investors around the world pay these firms for their research and analysis about the quality of a bunch of different types of debt, especially government bonds, aka sovereign debt.

The same way individuals in America get a numerical credit score based on their track record of paying their bills, countries get a letter score from one of these firms based on how likely they are to pay the interest on their debt and avoid default. A triple-A rating is like having an 850 credit score — spotless. Low risk. Safe.

Of course, the Big Three are far from infallible. In the run-up to the 2008 financial crisis, all three issued overly rosy ratings on complex mortgage products that turned out to be little more than hot garbage (to borrow a technical term). And then, hot on the heels of the US subprime-mortgage crisis, European leaders accused the Big Three of accelerating the Continent’s sovereign debt crisis by being too aggressive in downgrading major economies. 

While governments have since moved to improve transparency and competition among the firms, the Big Three still control 95% of the debt-rating industry.

The Nasdaq Composite index slid roughly 2% Wednesday, leading the session's declines.

The decline comes after the tech-heavy index was on pace to see its biggest one-day drop since February. The Dow fell 326 points, or 0.9% and the S&P 500 slipped 1.3% by mid-afternoon.

The moves come after Fitch downgraded the US's credit rating late Tuesday after the US market had closed.

The 10-year Treasury yield remained relatively stable Wednesday after retreating from its highest level this year.

Still, some investors said stocks were due for a pullback after their run higher this year.

And despite the sell-off on Wednesday, Fitch's downgrade could take a backseat to Wall Street's data later this week, when companies including Apple, Amazon and Airbnb report earnings. The July labor report is also on deck.

"If earnings continue to be strong, it's likely today will be seen as a buying opportunity in short days," Louis Navellier, chairman of Navellier & Associates, wrote in a note on Wednesday.

After a monthslong search for a new leader, the Federal Reserve Bank of Kansas City announced Wednesday its appointment of Jeffrey R. Schmid as its new president and chief executive officer.

Schmid replaces Esther George, who announced in May last year that she would be stepping down in January after reaching the mandatory retirement age of 65.

Hailing from Nebraska, Schmid officially assumes the role on August 21, just days before the Kansas City Fed’s closely watched annual symposium at Jackson Hole, Wyoming.

He's currently the president and CEO of the Southwestern Graduate School of Banking Foundation at Southern Methodist University’s Cox School of Business.

“Jeff’s perspective as a native Nebraskan, his broad experience in banking, and his deep roots in our region will be an incredible asset to the Federal Reserve, both as a leader of the organization and in his role as a monetary policymaker," said María Griego-Raby, deputy chair of the bank’s board of directors, who led the search for George's successor, in a release.

The appointment illustrates how much the Federal Open Market Committee, the Fed group that determines monetary policy, has evolved in the past year. Austan Goolsbee was named president of the Chicago Fed in December 2022 and long-time St. Louis Fed President James Bullard announced he's stepping down later this month in July.

It's unclear whether Schmid favors a hawkish or dovish stance on addressing inflation. The Kansas City Fed president votes on monetary policy moves in 2025.

JPMorgan Chase CEO Jamie Dimon, head of the largest bank in the United States, said on Wednesday that while he doesn't "get worried" about the state of the US economy, he's closely watching fiscal spending, quantitative tightening and geopolitical turmoil for storm clouds ahead.

Government spending on President Joe Biden's green economy package and military operations are incredibly high, said Dimon during an interview with CNBC from Bozeman, Montana. "Debt levels are very high," he added, noting that the government keeps selling more of it.

Quantitative tightening, said Dimon, where the Federal Reserve sells off its assets in the open market, "could bite us at some point."

But he said Russia's invasion of Ukraine is what causes him the most agita.

"The humanitarian crisis in Ukraine is extraordinary," said Dimon. Energy and food shortages caused by the conflict could cause more hardship and increase global inflation, he said.

The world is seeing "serious" levels of "nuclear proliferation and nuclear blackmail," said Dimon. "The world's not that safe."

This level of geopolitical chaos, he said, hasn't been seen since World War Two. "The world's not that safe."

Still, Dimon pointed out that the US consumer remains resilient and unemployment is low. If the United States does enter a recession, he said, it's entering with strong balance sheets that will pad the impact.

JPMorgan Chase CEO Jamie Dimon said Wednesday Fitch's downgrade of US debt is "ridiculous."

"It doesn't really matter that much," he said during a CNBC interview from Bozeman, Montana, adding that Fitch pointed out "some issues which we all knew about.”

The markets decide how debt is rated, he added, not an agency, and "the US has the best credit in the world."

Dimon did criticize the debt ceiling, which he said is used as a tool by both political parties to the detriment of the country. Without such a limit, he said, there would be more economic certainty.

US Treasury Secretary Janet Yellen doubled down on her criticism of Fitch's downgrade of US debt holdings in remarks Wednesday.

Yellen pointed at the US economy's robust performance in recent months, with inflation slowing to its weakest pace since the spring of 2021 and the unemployment rate remaining historically low.

The Treasury secretary also praised political governance in the US — which Fitch cited as the main reason for its downgrade.

"Its flawed assessment is based on outdated data and fails to reflect improvements across a range of indicators, including those related to governance, that we’ve seen over the past two and a half years," Yellen said.

"Despite the gridlock, we have seen both parties come together to pass legislation to resolve the debt limit, as well as to make historic investments in our infrastructure and American competitiveness."

But debt-limit standoffs have become somewhat of a bargaining tool for congressional lawmakers in recent years.

While bills that Congress passed to invest in US infrastructure and the production of semiconductors had bipartisan support, other major spending packages, such as the American Rescue Plan, did not.

The downgrade points to the increasingly unsustainable nature of US sovereign debt, which can undermine the country’s ability to pay for Americans needs and wants in the years ahead.

Despite that, the United States maintains its sacrosanct reputation among investors as a nation that makes good on its financial obligations.

"At the end of the day, Fitch’s decision does not change what all of us already know: that Treasury securities remain the world’s preeminent safe and liquid asset, and that the American economy is fundamentally strong," Yellen said.

Will Fitch's downgrade mar the reputation of US Treasuries as the ultimate safe asset?

Probably not.

Here's what CNN reported earlier this year:

"Any credit rating movement would be more of an embarrassment to the US than an impact to investors,” said Patrick Klein, portfolio manager at Franklin Templeton Fixed Income.

Several reasons underscore Treasuries’ pristine reputation, including that no other country has a currency market that is as liquid, large or highly rated as that of the United States.

“The US government issues something the rest of the world desperately wishes it had,” Josh Lipsky, senior director of the Atlantic Council’s GeoEconomics Center and former adviser at the International Monetary Fund, wrote in May.

The government is seen as a far more stable entity than a corporation, for instance, since it can impose taxes and take other measures to ensure it doesn’t run out of cash. That makes it an ideal issuer of debt.

Other safe assets exist but pale in comparison to Treasuries. Gold, for example, is a haven prized for its price stability even when the rest of the market experiences volatility.

But the precious metal’s prices are beholden to factors that government debt is not, including a supply that is controlled by miners. That makes the market too risky to underpin a financial system in the same way as the US Treasury market, said Olivier d’Assier, head of APAC applied research at Qontigo.

Plus, Treasuries are denominated by the US dollar, the world’s leading reserve currency — a position unlikely to be supplanted by another form of exchange such as gold, despite the value that it holds.

“It’s not like we all carry around a bunch of gold bars in our pockets to use at the grocery store,” said George Mateyo, chief investment officer at Key Private Bank.