Morning Market Update

S&P Downgrade of US Credit Rating Slams Stocks

The US equity markets are under solid pressure in early action as traders react to the late-Friday downgrade of the US credit rating by Standard & Poor’s, while the eurozone debt concerns continue to fester, despite optimism that the European Central Bank is buying debt of Italy and Spain. As the equity markets are under broad-based pressure, Treasuries are gaining ground despite the S&P downgrade amid some flight-to-safety buying. There are no major US economic reports scheduled for today to divert some attention away from the global debt crisis, but the Federal Reserve meeting and retail sales are some key reports set for later in the week. Equity news is relatively light, with Dow member Verizon Communications Inc gaining attention after workers went on strike over the weekend, while United Continental Holdings Inc reported a decline in traffic in July. Meanwhile, the US dollar is mixed compared to the major world currencies. Overseas, Asia finished broadly lower, while European markets are under pressure, except for markets in Italy and Spain.

As of 8:43 a.m. ET, the September S&P 500 Index Globex future is 25 points below fair value, the Nasdaq 100 Index is 54 points below fair value, and the DJIA is 222 points below fair value. WTI crude oil is $3.82 lower at $83.06 per barrel, and the Bloomberg gold spot price is up $38.97 at $1,702.93 per ounce. Elsewhere, the Dollar Index—a comparison of the US dollar to six major world currencies—is up 0.2% at 74.75.

Dow member Verizon Communications Inc. (VZ $35) is in focus today, as 45,000 workers went on strike over the weekend as the company and its union failed to reach a new labor agreement after their contract expired. The work stoppage is centered in VZ’s wireline business opposed to its wireless service and the company said its customers should expect no changes to network quality during the strike, which is the first in 11 years.

United Continental Holdings Inc. (UAL $17) reported that its traffic in July dipped 0.1% year-over-year (y/y)—the third-consecutive monthly decline per Dow Jones News Wires—though the air carrier’s consolidated passenger revenue per available seat mile for its United and Continental airlines increased 7.5% y/y.

Treasuries higher despite S&P downgrade of US credit rating

Treasuries are moving to the upside in early action as traders are seeking shelter from the steep losses in the equity markets, buying US debt despite late-Friday’s downgrade by Standard & Poor’s (S&P) of the US’ credit rating. The yield on the 2-year note is down 3 bps to 0.26%, the yield on the 10-year note is 7 bps lower to 2.49%, and the 30-year bond rate is declining 3 bps to 3.82%.

S&P lowered its long-term credit rating on the United States to AA+ from AAA. At the same time, it affirmed the A-1+ short-term rating and removed both ratings from credit watch, but held the long-term outlook as negative. This means that another downgrade is possible within the next two years if there is less deficit reduction than expected or economic or financial conditions change, as Schwab’s Fixed Income Strategist Kathy Jones discusses in her article, US Credit Rating Downgrade, noting that S&P’s rationale for the downgrade was its assessment that the recently negotiated budget agreement fell short of what is needed to stabilize the rising US debt. An additional factor for S&P was the contentious nature of the budget process itself, which has reduced its confidence in the ability of policymakers to address rising US deficits.

Kathy adds that it's important to remember that a credit rating is an opinion issued by a private organization, not a seal of approval. And S&P is only one of three major rating agencies. The other two--Moody's Investors Service and Fitch Ratings--have not lowered their ratings, although they assigned a negative outlook. Nonetheless, credit ratings do matter. Investors use credit ratings as a standardized way of assessing and comparing the risks of various issuers and securities, just as banks often use credit scores to assess the risk of an individual borrower. It is only one of many metrics that investors use when buying bonds, but it is an important one. While the downgrade by S&P may be potentially disappointing for the markets, we don't believe that it will necessarily cause borrowing costs to rise or that it will have much impact on the real economy in the short run. It is the opinion of one entity, albeit an influential one, but our view is that the impact is likely to be limited. It may cause some erosion in investor confidence in the near term. Of course, if the longer-term budget issues are addressed in a credible way, we would expect confidence to recover.

Meanwhile, there are no major economic reports scheduled for release today, but this week’s data kicks into gear tomorrow with what will likely be the headlining event, the conclusion of the Federal Open Market Committee’s (FOMC) monetary policy meeting. No major changes to the Fed’s stance are expected and the statement will be released at 2:15 p.m. EST. In light of the dramatic events in the market recently, traders will be looking for any signs on whether the recent string of soft data and decline in confidence will evoke a response hinting to a new round of quantitative easing (QE3). The Fed downgraded its assessment of the economy at the last meeting, citing some temporary factors, but in the press conference following the meeting, Fed Chair Bernanke said some of the headwinds such as weakness in the financial sector and housing market “may be stronger and more persistent than we thought.” Nonetheless, Bernanke quelled ideas about a potential QE3 by saying that differences from last fall included improvement in the job market and the mitigated risk of deflation.

Meanwhile, advance retail sales, set for release on Friday, will be the other major economic reading on the US’ economic docket, forecasted to rise 0.5% month-over-month (m/m) during July, after gaining 0.1% in June, while sales ex-autos and ex-autos and gas are both estimated to grow 0.2% m/m. Same-store sales results for July from the nation’s retailers reported last week were generally better than expected.

Other releases on this week’s US economic calendar include: the NFIB Small Business Optimism Index, MBA Mortgage Applications, business inventories, weekly initial jobless claims, wholesale inventories, non-farm productivity and unit labor costs, the trade balance, and the preliminary University of Michigan Consumer Sentiment Index reading for August.

Europe mostly under pressure despite ECB bond buying

The equity markets in Europe are trading mostly below the flatline in afternoon action as the uneasiness regarding the downgrade of the US credit rating by S&P is overshadowing the European Central Bank’s (ECB) statement late-Sunday that suggested it will purchase bonds of Italy and Spain. The purchases by the ECB is part of its recently announced plan to combat contagion of the euro-area debt crisis that has threatened key eurozone nations of Italy and Spain. Stocks in Spain and Italy are the lone advancers in the region, led by banking issues, as the expected bond purchases by the central bank are sending yields on Italian and Spanish bonds lower. However, the euro has given up early gains and is lower versus the US dollar in afternoon trading. Meanwhile, the steep declines in most of the major European equity markets come despite finance ministers and central bank governors that make up the G-7 and G-20 pledged to “take all necessary measures to support financial stability and promote growth.”

The economic calendar across the pond is relatively light and is taking a back seat to the focus on the global debt concerns, but reports showed business sentiment in France dipped slightly in July, and eurozone investor confidence unexpectedly fell into negative territory for August.

The UK FTSE 100 Index is down 1.5%, France’s CAC-40 Index is falling 1.7%, and Germany’s DAX Index is dropping 2.2%, while Italy’s FTSE MIB Index is up 0.2% and Spain’s IBEX 35 Index is gaining 0.3%.

Asia falls despite efforts to calm the markets

Stocks in Asia posted solid broad-based losses as sentiment was rattled by the late-Friday US credit rating downgrade by S&P and the festering eurozone debt crisis. The steep declines in the region came even as the G-7 and G-20 pledged to support financial stability and the ECB suggested that it will buy bonds from Italy and Spain, while Japan said it was prepared to intervene in the currency markets if speculative trading drives the yen higher. However, the yen is trading higher amid some flight-to-safety buying. Japan’s Nikkei 225 Index and Hong Kong’s Hang Seng Index both finished down 2.2%, while Australia’s S&P/ASX 200 Index fell 2.9%. Elsewhere, China’s Shanghai Composite Index and South Korea’s Kospi Index were some of the biggest decliners after both indices closed 3.8% lower. The hardest hit sectors were industrials, financials, and basic materials.