Introduction: US government shutdown bad for country’s credit, warns Moody’s
Good morning, and welcome to our rolling coverage of business, the financial markets and the world economy.
The possibility of a US government shutdown is looming over global markets today, and threatening America’s triple-A credit rating.
Overnight, credit rating agency Moody’s warned that dysfunction in Washington DC would reflect negatively on the country’s rating.
Moody’s is the last of the Big Three credit who still gives the US a AAA rating with a stable outlook (the gold standard for credit worthiness).
It warned:
A shutdown would be credit negative for the US sovereign.
In particular, it would demonstrate the significant constraints that intensifying political polarization put on fiscal policymaking at a time of declining fiscal strength, driven by widening fiscal deficits and deteriorating debt affordability.
There are just a few days left for Capitol Hill to avert a shutdown, by passing a spending bill by 1 October. If that doesn’t happen, the federal government will be left without funding.
That is expected to force hundreds of thousands of federal workers to go without pay and bring a halt to some crucial government services.
Moody’s analyst William Foster told Reuters:
If there is not an effective fiscal policy response to try to offset those pressures … then the likelihood of that having an increasingly negative impact on the credit profile will be there.
And that could lead to a negative outlook, potentially a downgrade at some point, if those pressures aren’t addressed.”
But there is deadlock in Washington DC, where a group of rightwing Republican members of the House of Representatives are refusing to reach a compromise with their own party’s leadership over a spending bill.
Moody’s predicts that a shutdown would probably be shortlived, and likely not to affect government debt service payments.
But the row is focusing investors’ attention on US creditworthiness, at a time when the interest rates on sovereign bonds are rising on fears that interest rates will stay higher for longer than hoped.
Treasury Yield Curve (10Y-2Y) is the steepest since May. Bear Steepening occurs when long-term yields rise faster than short-term yields and is commonly seen before recessions materialize. pic.twitter.com/fFW3jJ5MQv
— Barchart (@Barchart) September 26, 2023
Kyle Rodda, senior financial market analyst at Capital.com, says:
While what these agencies rate most government debt means diddly-squat, it does say something about the dysfunction in the US government….
Moody’s warning is a reminder of the costs of an unstable Government.
Just last month, Fitch downgraded the US government’s top credit rating, blaming the “steady deterioration in standards of governance”, following the row over lifting the US debt ceiling.
Also coming up today
Gatwick, the UK’s second largest airport, is expected to announce details of flights which are being cancelled this week due to a shortage of staff in air traffic control.
Thousands of passengers flying to and from Gatwick this week are expected to suffer disruption, after it imposed an immediate cap on Monday of 800 flights taking off or landing a day.
The airport said it would share the total of 164 cancellations proportionately between airlines until Sunday, with easyJet passengers most likely to be affected given the carrier operates just under half of all Gatwick flights.
People travelling on Friday are most likely to be hit, with 865 flights scheduled to depart.
The agenda
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8am BST: European Central Bank chief economist Philip Lane speaks at a conference “Monetary Policy Challenges for European Macroeconomies”.
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2pm BST: US house price index for July
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3pm BST: US consumer confidence for September
Key events
JPMorgan settles Epstein lawsuits with US Virgin Islands and Jes Staley
JPMorgan Chase has reached a $75m settlement with the U.S. Virgin Islands (USVI) to resolve a lawsuits over sex trafficking by the disgraced financier Jeffrey Epstein.
The largest US bank has also reached a settlement with former executive Jes Staley, the terms of which are confidential.
JP Morgan had been sued by prosecutors in the USVI, where Epstein had a home on the private island of Little St James. A trial had been due to start next month, with USVI seeking at least $190m from the company.
JPMorgan said its $75m settlement with the USVI includes $30m to support charitable organizations, $25m to strengthen law enforcement to combat human trafficking, and $20 million for attorney’s fees.
JP Morgan says today:
“While the settlement does not involve admissions of liability, the firm deeply regrets any association with this man, and would never have continued doing business with him if it believed he was using the bank in any way to commit his heinous crimes.”
Earlier this month, a lawyer for the US Virgin Islands said that JPMorgan Chase told US authorities it processed more than $1bn for Epstein over 16 years.
Epstein had been a JPMorgan client from 1998 until 2013, when the bank terminated their relationship.
In March, JP Morgan sued Jes Staley, who had run its private bank, over his relationship with Epstein.
Wall Street has opened in the red, as traders fret about a possible US government shutdown, and the prospect of US interest rates staying higher for longer.
The Dow Jones industrial average has dropped by 170 points, or 0.5%, to 33,836 in early trading, while the broader S&P 500 is down 0.8%.
Back in the UK, the Bank of England’s forecasting record is under some scrutiny from former top US central banker Ben Bernanke.
Bernanke has been engaged to assess the Bank’s forecasting operation, after it failed to predict the surge in inflation last year.
The terms of reference of the Bernanke review were published yesterday, and show that it will examine whether the Bank should continue to use the market path for interest rates when creating its forecasts.
Currently, the Bank’s inflation and growth forecasts are based on where the financial markets think it will set interest rates. The Fed, in contrast, produces ‘dot plots’ where policymakers estimate where they think rates will be.
Professor Costas Milas of University of Liverpool has analysed the Bank’s record, and writes in The Conversation that the Bank’s prediction department struggled in the last couple of years, as this chart shows:
He explains:
This demonstrates the bank’s under-predicting of inflation in 2021 (red line vs black line) – particularly compared to the international VAR model, in yellow.
It also shows the bank substantially over-predicted peak inflation in the final quarter of 2022, expecting 13.1% when it came in at 10.8%. After making that prediction in August 2022, the bank raised the benchmark interest rate by 0.5 points when it had previously only been raising at 0.25 points. It then raised by 0.5 points in September and by 0.75 points in November.
Without this over-prediction, the bank may not have sanctioned such panic rises. This would have put less pressure on the public and potentially made it less likely that the UK will tip into recession in the coming months.
US house prices rise in July
US house prices continued to rise in July, despite the burden of higher interest rates on the property sector.
The Federal Housing Finance Agency has reported that US house prices rose by 0.8% in the month of July, and were 4.6% higher than a year ago.
Dr Nataliya Polkovnichenko, supervisory economist in FHFA’s Division of Research and Statistics, says:
US house prices continued to appreciate in July, consistent with the trend observed over the last several months.
Regionally, all nine census divisions posted positive price appreciation over the last 12 months, although the Pacific and Mountain divisions experienced only modest growth.
A majority of City economists believe the Bank of England has raised interest rates for the last time in this cycle, a poll by Reuters shows.
Reuters surveyed 62 analysts, and 47 predicted that the BoE will leave interest rates on hold again at 5.25% at its next meeting in November, as it also did last week.
The survey also found that UK rates are expected to remain on hold until at least next July, before dropping to 4.75% by the end of 2024.
Ryanair calls for action over NATS ‘shambles’
Budget airline Ryanair has waded in over the flights cancellations at Gatwick this week, due to air traffic control staff shortages.
Ryanair is calling on the Civil Aviation Authority (CAA) to immediately intervene and protect passengers from further disruptions to flights to and from Gatwick over the next week.
The airline says it is unacceptable that Nats (which runs UK Air Traffic Services) is not adequately staffed, and wants NATS CEO, Martin Rolfe, to either fix UK ATC staff shortages or immediately resign.
A Ryanair spokesperson said:
It is unacceptable that airlines have been asked to cancel flights to/from Gatwick Airport for the next six days (until 2 Oct) as a result of NATS’s failure to adequately staff UK ATC. It is the most basic requirement to hire and train adequate staff numbers including standby coverage.
NATS has been a shambles for years, causing unnecessary disruptions at UK airports including Bristol, Edinburgh and Manchester, and now Gatwick Airport for the past four weeks including the complete system meltdown on Mon 28 Aug, which brought UK aviation to its knees – a mess that has still not been explained.
It is clear that NATS CEO, Martin Rolfe has taken no action to resolve these ATC staff shortages and should now do the right thing and step down as NATS CEO so that someone competent can do the job. We call on the CAA to immediately intervene and protect passengers from this ongoing UK ATC shambles.
Ryanair also says it will not be cancelling any Gatwick flights, although a few flights to and from the airport have been delayed today.
UK economy ‘at risk of stagnation’, S&P warns
Another credit rating agency, S&P Global Ratings, has today published its UK Economic Outlook.
The report has found that economic growth in the U.K. is set to remain muted well into 2024. That’s due to the impact of high inflation, and monetary policy rates which will turn increasingly restrictive in real terms as inflation abates.
S&P has slightly increased its growth forecast for this year, to 0.3% growth, from zero.
But 2024’s growth forecast has been cut to 0.5% from 0.8%, as some of the shlowdown is shifted into next year.
The report also finds that:
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S&P expect the U.K. economy to continue its path of muted growth, close to stagnation, into 2024, as real interest rates become increasingly restrictive.
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Headline inflation remains high, but S&P expect it to gradually fall back close to target in the second half of 2024.
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The BoE may have raised interest rates for the last time in this cycle, provided pay growth also eases soon.
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Real wage growth has turned positive. Together with a labour market that should remain firm by historical standards, this should mitigate an otherwise constrained growth environment.
Russell Investments’ strategists expect a mild recession for the US economy in 2024, despite the Federal Reserve’s afforts to pull off a ‘soft landing’.
They’ve released their Global Markets Outlook for the fourth quarter of this year. It highlights that other developed economies are also under stress from aggressive monetary tightening, with Europe appears on the verge of recession and the U.K. economy continues to stagnate.
Andrew Pease, global head of investment strategy at Russell Investments, says:
A soft landing for the U.S. economy where recession is avoided is possible but we still think a mild recession is likely.
Fed Chair Jay Powell’s attempt at a soft landing for the U.S. economy may have an even higher degree of difficulty than airline pilot Sully Sullenberger’s miracle landing on the Hudson in 2009.
Jamie Dimon, the head of investment bank JP Morgan, has caused a stir by suggesting that US interest rates could rise as high as 7%.
Speaking to the Times of India, Dimon suggested the worst case scenario is that the US experiences 7% interest rates “with stagflation”.
Last week, the Federal Reserve left its key interest rate at a range of 5.25%-5.5%, although a majority of its policymakers expect one more increase by the end of the year.
Many analysts believe the Fed is near to ending its cycle of interest rate rises. But Dimon argued that businesses are not prepared for how high rates may go.
Asked about the risks of a hard landing in the US economy, Dimon said:
First of all, interest rates went to zero. Going from zero to 2% was almost no increase. Going from zero to 5% caught some people off guard, but no one would have taken 5% out of the realm of possibility. I am not sure if the world is prepared for 7%.
The selloff in bond markets is showing no sign of easing, says Raffi Boyadjian, lead investment analyst at XM.
That is pushing the yields, or interest rates, on government debt higher, weighing on share prices.
Boyadjian explains:
Higher yields are weighing on European and Asian equities for a second day. Adding to the risk-off mood is news that China’s property giant, Evergrande, missed a bond payment, and a warning by ratings agency Moody’s that it may downgrade its rating on US debt if there is a government shutdown.
A credit downgrade could exacerbate the selloff in US Treasuries, which, apart from Fed tightening, are under pressure from the massive issuance in new debt.
The US AAA rating with Moody’s is at risk because politics appear to be standing in the way of fiscal policymaking, explains Victoria Scholar, head of investment at Interactive Investor:
As the 1st October deadline next Sunday inches closer when the next fiscal year begins, there are concerns about a partial government shutdown which would cause significant disruption including the risk that thousands of government workers won’t get paid.
At the moment, Moody’s maintains its “Aaa” rating with a stable outlook. However last month, in a surprise move, another ratings agency Fitch downgraded the US to AA+ despite the Republicans and the Democrats having reached a debt ceiling deal. And there is a worry now that Moody’s could follow suit.
Politics appear to be standing in the way of fiscal policymaking. The US economy has so far proven to be more resilient than expected with inflation coming down and minimal signs of a significant slowdown. However, a shutdown and a credit downgrade have the potential to derail the robustness of the US economy.
Concerns about what happens over the next week combined with hawkish Fed commentary have sparked risk-off sentiment across markets with US futures pointing to a weaker open and European markets trading mostly in the red.
Europe’s banks helped fossil fuel firms raise more than €1tn from global bond markets
Jillian Ambrose
Banks including some of Europe’s largest lenders have helped fossil fuel companies to raise more than €1tn (£869bn) from the global bond markets since the Paris climate agreement, according to an investigation by the Guardian and its reporting partners.
In the push to zero carbon, Europe’s biggest lenders face growing pressure to limit their financial support for fossil fuel companies through direct loans and other financing facilities.
But analysis of thousands of transactions since 2016, when more than 190 countries agreed at a UN summit in Paris to limit global warming by curbing pollution, has revealed that lenders including Deutsche Bank, HSBC and Barclays have continued to profit from the expansion of oil, gas and coal by supporting the sale of fossil fuel bonds.
The findings have raised concerns among sustainable investment campaigners that banks are continuing to offer “hidden” financial support to energy companies that are responsible for increasing the world’s carbon emissions – even as they pledge publicly to phase out direct lending for new projects.
The Guardian worked alongside other European newspapers and the Dutch platforms Investico and Follow the Money to look in detail at 1,700 bond issues recorded by the financial information provider Bloomberg.
In the property sector, the US tech giant Meta has paid £149m to break its lease on a major London development near Regent’s Park.
Commercial property developer British Land told the City this morning that Meta had surrendered its least on 1 Triton Square – one of the two buildings it has leased at Regent’s Place – yesterday, at a cost of £149m.
The move somes as major companies adjust their property needs due to the move towards home working following the Covid-19 pandemic.
Simon Carter, CEO, is looking on the positive side, though, saying:
Meta’s surrender of our building at 1 Triton Square also enables us to accelerate our plans to reposition Regent’s Place as London’s premier Innovation and Life Sciences campus.”
British Land has said it will “accelerate” plans to reposition Regent’s Place following Meta’s surrender of 1 Triton Square. The tech giant officially handed back the lease for the 310,000 sq ft building yesterdayhttps://t.co/uvA4GqzGEn via @PiersWehner
— Tim Burke (@_tim_burke) September 26, 2023
European stock markets in the red
European stock markets have lost more ground this morning, with the Stoxx 600 index down by 0.35% so far.
Germany’s DAX, France’s CAC and Italy’s FTSE MIB indices are all down over 0.4%, while the UK’s FTSE 100 is 12 points (0.17%) higher.
Pierre Veyre, technical analyst at ActivTrades, says investor risk appetite is decreasing – partly due to concerns of a US government shutdown within days.
All Eurozone benchmarks were in the red shortly after the opening bell, led lower by real estate and consumer cyclical shares, as sentiment stays under pressure by several market drivers.”
Lingering inflation and higher rates concerns are keeping investors from increasing their exposure to riskier assets, and the prospect of a Federal shutdown in the US next week is also adding pressure to market sentiment. Indeed, a lack of a funding agreement from the US Congress would likely negatively impact the country’s credit rating, according to Moody’s, further denting confidence in the nation’s economic outlook.”
“Stock investors also face another bearish pressure from China as property fears grow following a missed payment from the sector’s giant, Evergrande. This highlights concerns over the management of the property sector’s debt pile and leads to uncertainties about the overall recovery in the second-biggest economy in the world.
Dark clouds continue to pile up for investors, and the next batch of macro data is likely to be scrutinised by most to determine where risky assets may go soon.
