Moody’s Bank Ratings Actions Drive Risk-Off Day

Bank downgrades send rates lower. Swap rates and Treasury yields fell across the curve today on economic concerns fueled by a Moody’s downgrade of several U.S. banks. Meanwhile, Q3 U.S. Treasury issuance kicked-off today with a $42 billion, 3-year note auction that saw strong demand drive lower-than expected yields. Overseas, a 14.5% YoY decline in Chinese exports, the steepest drop since February 2020, spurred concerns of a Chinese economic slowdown. Short-term yields declined slightly in response to today’s developments, with the 2-year yield down ~1bp to 4.76%, while the longer-end felt more downward pressure with the 10-year yield declining 7bps to 4.02%.

Bank credit downgrades highlight key sector risks. Moody’s downgraded certain SMID-cap U.S. lenders and put some larger banks under ratings review today. The agency said higher funding costs, regulatory capital weaknesses and CRE risks drove the action. Higher rates were a key culprit, as they can squeeze bank earnings and degrade the value of fixed-rate assets. Elevated CRE risks were also in focus due to high rates and lower office demand. The agency concluded from Q2 bank earnings commentary that, “growing profitability pressures…will reduce their [banks] ability to generate internal capital.” Bank stocks were down on the news, with the KRE opening ~3.2% below yesterday’s close, but clawed back some losses intraday, ending ~1.2% below yesterday’s close at $48.41.  

Fed commentary supports “higher for longer” narrative. Speeches from the Fed’s Harker and Barkin today offered few clues on a September hike, but one theme remained consistent with recent Fedspeak: rates will need to stay sufficiently restrictive for longer. Harker argued that the Fed may be at a point where it can hold rates steady, but he added, “should we be at that point where we can hold steady, we will need to be there for a while…I do not foresee any likely circumstance for an immediate easing of the policy rate.” He echoed yesterday’s comments from the Fed’s Williams and Bowman, who said, “I expect that we will need to keep a restrictive stance for some time,” and “I will be looking for evidence that inflation is on a consistent and meaningful downward path,” respectively.