Wall Street Breakfast Podcast: U.S. AAA Rating On Negative Watch

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Leading today’s news: The United States is in danger of losing Fitch Ratings' top sovereign debt status due to "increased political partisanship that is hindering reaching a resolution to raise or suspend the debt limit."

Fitch is reviewing the U.S. for a potential downgrade on its long-term foreign currency issuer default rating. The AAA top rating is now on Ratings Watch Negative.

The U.S. lost its top rating at S&P in 2011 as the government approached default in a similar standoff. S&P has not restored the U.S. to its highest rating. Moody’s still has a top rating on the U.S. Debt ratings are important because lenders base interest rates on a borrower's creditworthiness.

Fitch says it "still expects a resolution to the debt limit before the X-date." That’s when the U.S. Treasury exhausts its ability to pay its obligations.

"However, we believe risks have risen that the debt limit will not be raised or suspended before the x-date and consequently that the government could begin to miss payments on some of its obligations" it added.

One caveat here – neither Fitch, nor anyone else, knows when the precise X-date is. Treasury Secretary Janet Yellen has said that the X-date is likely on June 1, but it is not confirmed.

On the debt limit negotiations, no firm progress was announced after talks Wednesday, but House Speaker Kevin McCarthy said he believes they "can get to yes." on a debt limit deal. He also insisted that the U.S. won't default.

But Congress will leave D.C. without voting on a deal with the weeklong Memorial Day recess scheduled to begin on Thursday as planned. Rep. Steve Scalise said members will receive 24 hours notice in the event of an agreement.

Despite the Fitch move, the dollar index (DXY) is up slightly in morning trading.

In other market news -

AI to the rescue. Nvidia (NASDAQ:NVDA) shares surged 20% in premarket after the semiconductor giant posted first-quarter results that topped expectations and blew away forecasts for the upcoming period.

"Demand [related to generative AI and large language models] has extended our data center visibility out a few quarters and we have procured substantially higher supply for the second half of the year," Nvidia execs said on an earnings call. "The easiest way to think about that is over the next four or five, 10 years, most of that trillion dollars, and compensating adjusting for all the growth in data center still, it will be largely generative AI."

Nvidia is indicated to open on Thursday with a market-cap gain of more than $185B, making it worth more than Meta or Tesla.

It might even turn into the biggest single-day record (Apple rose by $191B in November 2022).

Peers are riding the sentiment higher, such as rival chipmaker AMD (NASDAQ:AMD), AI software maker C3.ai (NYSE:AI) and Palantir (NYSE:PLTR) – all up around 8%. Bigger players like Microsoft (MSFT) and Alphabet (GOOG) (GOOGL), are also higher.

But the jury is still out on artificial intelligence.

There's no doubt that companies are on the brink of something big, and that it will change many industries and how we do things, but it's important to separate hype from reality when talking about any emerging technology. Remember the Internet of Things? Web 3.0? The metaverse? DeFi, blockchain, and NFTs? Many shares related to companies operating in these spaces have seen their prices dwindle from the record highs seen when the news cycle was played up.

Contrast that to smartphones, streaming, e-commerce and the cloud, which have had much more lasting impacts on business investment, the labor market and broader economy.

Goldman Sachs says it remains bullish on crude oil and other major raw materials, anticipating a rally following the "largest-ever commodity de-stocking the complex has ever witnessed"

Goldman admitted its price calls have been wrong so far this year, but also said "bulls, like ourselves, find comfort in the fact that end-use demand across the commodity complex has not shown recessionary signs and investment in supply remains elusive."

Recessionary concerns, higher interest rates and healing in global supply chains have led to a broad de-stocking of wholesale goods and inputs. That’s created weaker industrial production and stoked recessionary fears, but does not reflect weak end-user demand, they said.

Goldman’s bottom line: "markets have cashed in on their insurance policies in the form of physical and financial hedges."

The May Fed minutes arrived and notes showed that FOMC members were split on the need for further rate increases, but there was less urgency for a hike next month.

With the increased risks, participants "generally expressed uncertainty about how much more policy tightening may be appropriate." But some said additional "policy firming would likely be warranted at future meetings," if progress in bringing down inflation to the Fed's 2% target remained "unacceptably slow."

“Many participants focused on the need to retain optionality after this meeting.”

Strategists and economists said the minutes tilted a little to a pause in June, with the FOMC having time to assess more data before making a definitive decision to end the tightening cycle.

Fed funds futures currently price in a 69% chance that the Fed holds steady in June, with a 39% chance of a quarter-point hike. The first rate cut has been pushed out to the December meeting.

J.P. Morgan global strategist Marko Kolanovic says a "Dissonance remains between the bond market that expects rate cuts this year, equity market interpretation of those potential cuts as positive for risk, and the Fed’s rhetoric not seeing any rate cuts."

He is bearish on stocks, saying "equity risk/reward as skewed to the downside, as upside potential for markets is likely fairly limited given stretched valuations and high rates."

The Fed staff's economic forecast expects further tightening in bank credit conditions, along with the already tight financial conditions to lead to a mild recession starting later this year. Real GDP was expected to decelerate over the next two quarters, then decline modestly in both Q4 2023 and Q1 2024.

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