Wednesday, August 2, 2023

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IN TODAY’S NEWSLETTER

• US debt downgrade

• Tether is making a lot of money

• More NFT evolution

• The DeFi saga

• BTC vs ETH

WHAT I’M WATCHING

US debt downgrade

Ratings agency Fitch has cut the US’s sovereign credit grade from the top AAA level down to AA+. Back in the height of the debt ceiling crisis, it had warned this could happen. Although that was resolved, the reasons given for the cut now is the likely deterioration of US finances over the next three years, driven by an increase in spending combined with tax cuts, economic shocks and political gridlock.

Why this matters:

The reasons given for the ratings cut are fair. The federal deficit hit nearly $1.4 trillion at the end of June, up a whopping 170% from a year ago. This adds to an already large federal debt, estimated at more than $32 trillion, that is now paying interest at the highest rate in almost 20 years. What’s more, there’s plenty more borrowing in the pipeline: earlier this week, the Treasury boosted its borrowing forecast for the current quarter to $1 trillion, well above the $733 billion it had predicted back in May. One of the main reasons for the increase is the ballooning interest cost, which – without curtailing government spending or without a drastic drop in interest rates, neither of which are likely any time soon – will continue to compound. Basically, it’s surprising that it took Fitch this long, and it probably won’t be long before Moody’s follows suit.

The impact on markets is likely to be muted, however. US government debt will continue to be seen as a “safe haven”, as it is still as unlikely as ever that the US will default. While there are other countries with higher sovereign debt ratings – Norway, Sweden, Australia, Germany, Denmark, Switzerland and Luxembourg, for example – their debt markets are much less liquid and carry greater currency risk.

US yields jumped yesterday, with the 10-year yield rising above 4% for the first time since early July (aside from a brief peek at the end of the month). This could be more down to positioning for the upcoming Treasury issuance, however.

(chart via TradingView)

Bond volatility as measured by the MOVE index did tick up, but is still notably lower than it has been for most of 2023 so far.

(chart via TradingView)

The main impact is one of reputation. This downgrade does not look good on the global stage, nor on the domestic one in the run-up to an election in which economic ideology is likely to play an outsized role, especially if the US finds itself in the grips of a recession.

I still believe that is the probable outcome. Yesterday’s ISM data showed that manufacturing activity in the US continued to contract in July, for the ninth consecutive month. Weak global demand pushed the gauge of exports down to its lowest level so far this year, and even the manufacturing employment index dropped to the lowest reading since July 2020. Manufacturing is no longer the mainstay of the US economy – that mantle has passed to services – but it is not an insignificant component of overall growth, and the employment data is likely to soon start showing up in the official statistics. What’s more, yesterday’s US job openings report showed a drop in June to the lowest level since April 2021.

This Friday, we get the official employment data for July which is expected to leave the unemployment rate steady at 3.6%. The job market is still tight, yet there are some signs of softening, and at some stage – it could be now or it could be in a few months – this number will unfortunately start to move up.

Tether is making a lot of money

Tether, the issuer of the $83.2 billion USDT stablecoin, reported earlier this week on its Q2 profit and reserves attestation, revealing a company that is not only well-backed, but also extremely profitable.

Why it matters: