Analysing Fitch's U.S. credit downgrade

Here's what it means.
Team Halogen
August 7, 2023

Global Macro Highlights 

Source: Reuters

🔻Fitch downgrades U.S. long-term rating to AA+ from AAA
📈 BOE raises rates to 5.25% with warning policy will remain tight
🏠 China’s Zhengzho city launches property support measures - a sign of concern in the nation’s real estate?
💼 US economy added 187,000 jobs in July as hiring cools

The US sovereign credit rating has now been downgraded to AA+ by two out of the three major rating agencies, with only Moody’s left standing. 

The markets…did not like it, to say the least. 

Coupled with a continued high inflation outlook thanks to stellar US ADP jobs data and household names like Bill Ackman reportedly short 30y treasury bonds, the price action since the news broke was a correlated selloff in most risk assets and a flight to safety play. 

The market did get a reprieve early Friday evening, as US Nonfarm Payroll data showed less jobs were added than economists were expecting. The Federal Reserve has been watching the labour market closely to make their policy decisions. 

However, despite the headline data missing expectations, the US unemployment rate was actually lower than estimated (3.5% vs. 3.6% estimated), while average hourly earnings were above expectations (4.4% YoY vs. 4.2% YoY expected). 

Given the Fed’s focus on wage inflation, those numbers are more crucial for gauging their policy response, and they don’t indicate that wage inflation is stabilising just yet.

Indeed, the initial reaction to the data was a bounce in risk assets and slightly lower treasury yields. The rally in equities couldn’t be sustained, and the SPX 500 closed below the key 4500 level.

While treasury yields moderated slightly into the Friday close, this surge in longer term rates introduces a fairly major risk in financial markets, by increasing longer term borrowing costs and tightening the supply of credit. If inflation doesn’t come down, then the Fed has no choice but to maintain its tighter for longer policy stance, and it'll be harder to bring longer term rates down.

That in term could exacerbate a credit crunch and weigh heavily on US financial markets.

Malaysian Markets Highlights

Source: Bloomberg
🇲🇾 Ringgit and Bursa Malaysia falls in knee jerk reaction to US debt downgrade

Well, our local markets weren’t spared from the fallout either. 

Bursa Malaysia's benchmark FTSE Bursa Malaysia KLCI, meanwhile, declined 6.68 points or 0.46% to settle at 1,444.56 from 1,451.24 at last Tuesday's close.

Despite outperforming the SPX 500 last week, our local bourse as well as our currency experienced pullbacks in their recent strength. 

Notably though, our currency is still showing a decent correlation to the Chinese Yuan, and with last week’s speculation about easing property measures in some tier 2 cities, the Ringgit has seen some respite from the global currency selloff against the US Dollar. 

Crypto Market Highlights

Source: TradingView
🆘 Curve Finance suffers $70M exploit after series of attacks
🦸 Looter behind $61M Curve hack starts returning assets, raising hope for recovery
🛑 Binance could face US fraud charges

It was a pretty exciting week in the digital asset space actually, even before considering macroeconomic headline impact. 

Curve Finance, one of the largest Decentralised Finance (DeFi) protocols on the Ethereum network, was subject to a code vulnerability exploit on July 30th that drained over $70 million in funds from their protocol. 

The majority of Curve’s $2.3 billion of TVL (total value locked) is still safe, but there was enough panic to introduce a large sell-off in related DeFi tokens. This was led by the CRV token and related protocols where large amounts of CRV were used as loan collateral.

There was also some knee jerk selling in the major digital asset pairs as Binance, still the world’s largest crypto exchange, continues to come under attack by US regulators and media. 

Since then though, things have calmed as several crypto native individuals, Justin Sun amongst them, stepped in to stabilise the situation at Curve. Following which, the exploiter accepted a bug bounty from Curve and has started to return some of the stolen assets. The CRV price has since recovered, though nowhere near its pre-exploit levels.

As for the crypto majors, Bitcoin and Ethereum did come under pressure during the panic earlier in the week, and were also not spared the broad selloff in risky assets later on. Bitcoin was pressured below the USD 29,000 price level several times this week, but has yet to confirm weakness with a weekly close below that price.

That said, Bitcoin actually surged at first on the news of the US rating downgrade. Similar to when Bitcoin outperformed during the March banking crisis, the asset clearly benefits from the anti-establishment narrative. 

What are we monitoring for the week ahead

What does all of this mean? Our thoughts 

While the recent macro developments have put a damper on crypto sentiment and prices, Bitcoin has thus far had relatively lower correlation to traditional financial assets this year. 

Dips in the pair since the spot ETF news have been shallow, though we suspect that a lot of the buying in the USD 29,500 to 30,000 region has been retail interest that’s late(r) to the party.

That said, it’s a bit too much to hope that Bitcoin can fully escape the fallout of higher rates, and the following correlated selloff in risk assets which might result. 

Some weaker trading positions might also start to capitulate should things take a turn lower, at which point it is not a stretch for BTCUSD to trade back to USD 28,000 levels. 

Zooming out a bit further on Bitcoin, the recent outperformance in Bitcoin is primarily due to the filing by global fund manager Blackrock for a spot Bitcoin ETF back in June. 

Shortly after the news broke, the pair rose nearly 25% from a base of USD 25,000 to an interim high of USD 31,400. The pair proceeded to trade in a range from USD 29,500 to USD 31,800 for most of July, as the ETF narrative cooled. 

While retail interest was no doubt piqued, it’s also notable that large holders of Bitcoin were spotted accumulating even more of the token. 

According to Santiment, a prominent blockchain analytics data provider, so-called Bitcoin whales (wallets holding 100 BTC or more) added nearly 28 thousand additional BTC in total to their already sizable holdings, going back to May 16th of this year. 

As we eagerly await the commencement of our Halogen Shariah Bitcoin Fund, we’ll be happy to see any dips in the price of Bitcoin. 

We’ve long maintained that some of the exuberance from the ETF headline needed to be flushed out, but should it come to fruition, will be an immediate game changer.

Of course, there is the risk of the SEC delaying or outright rejecting those applications, but with some prudent portfolio management and market timing, the upsides definitely outweigh the downsides. 

See you next week!

Team Halogen

The information, analysis, and viewpoints presented here are intended solely for general informational purposes and should not be construed as personalised advice or recommendations for any specific individual or entity. For personalised investment decisions, individual investors are advised to consult their licensed financial professional advisor. The opinions expressed by the Manager are based on certain assumptions or prevailing market conditions, and they are subject to change without prior notice. This material is being distributed for informational purposes only and should not be regarded as investment advice or an endorsement of any particular security, strategy, or investment product. While the information provided herein may include data or opinions from sources believed to be reliable, its accuracy and completeness are not guaranteed. Reproduction of any part of this material in any form or reference to it in other publications is strictly prohibited without the express written permission from Halogen Capital Sdn Bhd. Halogen Capital Sdn Bhd and its employees assume no liability regarding the use of this material or its contents.

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October 27, 2023
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