Evening Brief – 08.15.23
Fitch Ratings cut the US government’s highest credit rating in early August to AA- from AA. Moody’s downgraded the credit ratings of small and mid-sized US banks last week due to greater funding costs, potential regulatory capital deficits, and rising risks associated with commercial real estate loans. Now, another week, another potential downgrade – this time involving major US banks.
Fitch Ratings analyst Chris Wolfe told CNBC that another round of instability for the US banking industry is possible. He pointed out that the ratings agency is considering major downgrades for dozens of banks, including JPMorgan Chase and Bank of America.
“Another one-notch downgrade of the industry’s score, to A+ from AA-, would force Fitch to reevaluate ratings on each of the more than 70 US banks it covers,” Wolfe said. “If we were to move it to A+, then that would recalibrate all our financial measures and would probably translate into negative rating actions.”
According to Wolfe, the downgrade of the operating environment score for US banks to ‘AA-‘from ‘AA,’ reflecting downward pressure on the US sovereign rating, gaps in the regulatory framework, and structural uncertainty around monetary policy normalization, went “largely unnoticed because it didn’t trigger downgrades on banks.”
Perhaps Fitch is testing the waters with a warning to Wall Street that another round of bank downgrades is a serious risk to the market in the wake of tight monetary policy and fiscal instability.
“What we don’t know is, where does the Fed stop? Because that is going to be a very important input into what it means for the banking system,” Wolfe added.
Swap contract rates referring to future Fed policy meetings indicate that rate hikes may have reached their peak, with rate cuts possibly starting in the second half of 2024; on Monday, Goldman Sachs penciled in the first cut around the same time.
The KBW Nasdaq Bank Index ETF fell about 3% on Tuesday and nearly 8% in the past week. Meanwhile, the US 10-year yield hit 4.27%, the highest level of the year and indicating the banking crisis is far from over.