- Dow Jones futures fall 0.3% after Fitch downgrades US credit rating to AA+.
- DJIA is overbought on daily RSI, trading near the 35,750 resistance level.
- US July ADP Employment Change arrives at 324K, way above 189K expectation.
- Analysts expect Friday’s July Nonfarm Payrolls data to decline to 200K.
The Dow Jones Industrial Average (DJIA) opened half a percentage point lower on Wednesday after Fitch downgraded the US federal government’s credit rating. Since the market is risk-off, the Dow is tracking better than the riskier indices. The S&P 500 index has fallen 0.8% at the same time, while the NASDAQ Composite reversed 1.2%
However, the ADP Employment Change data for July arrived before the opening, and provided a big surprise to the upside. The July data showed a positive change of 324K new jobs, well above the 189K expected by analysts. This reading tracked with the 497K ADP estimate from June, which was also an incredible upside surprise.
It is bad news for equity markets since it leads expectations higher for Friday’s Nonfarm Payrolls release. Higher employment gains lead to a tighter labor market and thus could provoke the Federal Reserve (Fed) to raise interest rates again in September.
Dow Jones Industrial Average News: Fitch surprises market with US downgrade
Fitch pulled a play right out of S&P Global Ratings’ playbook on Wednesday, releasing its downgrade on US government debt during the European morning session. S&P famously downgraded the US after a debt standoff in Congress in 2011.
Fitch dropped the US government one notch lower – from AAA to AA+. As it stands, this likely will not mean much for US Treasury yields since the US government borrows in its own currency. Still, the move has led to a sell-off at the riskier end of the market, and so relatively safer components of the Dow index are performing better than the tech and growth-heavy NASDAQ 100 index.
The US government recently overcame a debt standoff with the Republican-controlled House of Representatives in late May. Republicans had refused initially to raise the debt ceiling, but the Democratic Party, led by President Joe Biden, resolved the conflict by agreeing to some budget cuts and an increase in military spending. Fitch blamed an “erosion of governance” in the US and an expanding budget deficit for the downgrade.
IG Markets’ Alexandre Baradez told Bloomberg that she suspected the market was not all that worried about the rating cut but used it as an excuse to take profits. “I suspect that what’s currently being priced is the growing risk of an economic slowdown,” Baradez said. “The downward trend started to emerge yesterday on the back of disappointing Chinese and US data.”
In the case of the US, Baradez is referring to a disappointing July Manufacturing PMI that arrived at 46.4, below the 46.8 reading that analysts expected. The reading demonstrates that US manufacturing remains in a contractionary phase, but it was a tick-up from June.
Nonfarm payrolls could show soft landing or need for more hikes
The market has spent much of the week pondering whether the July Nonfarm Payrolls data will arrive as expected. Analyst consensus comes in at a flat 200K, just a bit below June’s 209K figure.
A much higher reading threatens to upend the soft landing thesis that many in the market have adopted. Even Federal Reserve Chair Jerome Powell said at his press conference on July 26 that a recession seemed less and less likely based on the current data.
A much higher NFP would suggest that the central bank might need to raise interest rates again to ensure that the US’s tight labor market does not lead this year’s pleasant disinflationary picture to end in favor of inflation stalling out near an annualized 4% rather than gradually tracking back to the Fed’s mandate for 2% core inflation.
The market wants July’s fed funds rate hike to be the end of the hiking cycle, and a figure slightly below or in line with 200K consensus would reinforce that narrative.
Additionally, analysts expect the Thursday release of July Services PMI to reflect a reading of 53, slightly down from June’s 53.9 figure. Service sector inflation has been harder for the Fed to control in 2023 than goods (manufacturing) inflation.
Earnings of the week
Wednesday, August 2 – CVS Health (CVS), Shopify (SHOP), PayPal (PYPL), Kraft Heinz (KHC), Humana (HUM)
Thursday, August 3 – Apple (AAPL), Amazon (AMZN), Amgen (AMGN), AirBNB (ABNB)
Friday, August 4 – Enbridge (ENB), Dominion Energy (D), fuboTV (FUBO)
What they said about the market – JP Morgan
JPMorgan surprised many traders on Monday by releasing a client note that said the much-hoped-for “soft landing” was an unlikely outcome for the market. The investment bank said that the Fed and other central banks were likely to keep interest rates high for longer than expected, which would likely hurt weaker companies on the periphery.
“We remain skeptical of this outcome, however, anticipating the inflation decline to prove incomplete, leaving restrictive policies in place that should increase private sector vulnerabilities and end the global expansion.”
What does the Federal Reserve do, how does it impact the US Dollar?
Monetary policy in the US is shaped by the Federal Reserve (Fed). The Fed has two mandates: to achieve price stability and foster full employment. Its primary tool to achieve these goals is by adjusting interest rates.
When prices are rising too quickly and inflation is above the Fed’s 2% target, it raises interest rates, increasing borrowing costs throughout the economy. This results in a stronger US Dollar (USD) as it makes the US a more attractive place for international investors to park their money.
When inflation falls below 2% or the Unemployment Rate is too high, the Fed may lower interest rates to encourage borrowing, which weighs on the Greenback.
How often does the Fed hold monetary policy meetings?
The Federal Reserve (Fed) holds eight policy meetings a year, where the Federal Open Market Committee (FOMC) assesses economic conditions and makes monetary policy decisions.
The FOMC is attended by twelve Fed officials – the seven members of the Board of Governors, the president of the Federal Reserve Bank of New York, and four of the remaining eleven regional Reserve Bank presidents, who serve one-year terms on a rotating basis.
What is Quantitative Easing (QE) and how does it impact USD?
In extreme situations, the Federal Reserve may resort to a policy named Quantitative Easing (QE). QE is the process by which the Fed substantially increases the flow of credit in a stuck financial system.
It is a non-standard policy measure used during crises or when inflation is extremely low. It was the Fed’s weapon of choice during the Great Financial Crisis in 2008. It involves the Fed printing more Dollars and using them to buy high grade bonds from financial institutions. QE usually weakens the US Dollar.
What is Quantitative Tightening (QT) and how does it impact the US Dollar?
Quantitative tightening (QT) is the reverse process of QE, whereby the Federal Reserve stops buying bonds from financial institutions and does not reinvest the principal from the bonds it holds maturing, to purchase new bonds. It is usually positive for the value of the US Dollar.
Dow Jones chart forecast
The Dow Jones index advanced 0.66% last week and, through Tuesday of this week, has already added 0.48%. In the middle of the resistance zone ranging from 35,200 to 35,750, the Dow looks poised to at least reach the top of the range or even break through it.
The index already broke through the top trendline of the ascending wedge formation on July 20. In a word, it seems unbothered by technical resistance levels. The index has severely underperformed the NASDAQ 100 and S&P 500 indices so far in 2023, and many traders view it as a means of keeping one foot in the market without adopting risk-on positions.
A break of 35,750 will send bulls stretching for the next profit-taking range of 36,500 to 36,952. However, the Relative Strength Index (RSI) is again witnessing overbought levels, and the market may decide to trim soon. Levels of support are nearby at 34,712 and 34,590.
Dow Jones Industrial Average daily chart
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