by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Our Comment today opens with news of potentially shoddy credit ratings being used in the booming private-credit industry. We next review several other international and US developments with the potential to affect the financial markets today, including a bit more detail on the Senate vote last night to fund the federal government again and movement toward a deal that would cut the US’s import tariffs against Switzerland from 39% to about 15%.

Global Private Credit Industry: A useful article in the Financial Times yesterday examined how a plethora of small, start-up credit rating firms has grown up to provide private-letter assessments of private credit deals. The new firms — including Morningstar DBRS, Kroll Bond Rating Agency, HR Ratings, and Egan-Jones — have allowed private capital providers to shop around for the best possible rating with little public transparency.

• As we noted in our Comment yesterday, insurers have become major participants in the private credit industry. They are especially keen to secure positive private letters so they can hold less capital against their loans.
• The risk is that the new start-ups will offer overly positive assessments, contributing to a possible over-extension of private credit that could foster a future debt crisis.
• That risk would harken back to the US housing bubble, when large, established agencies such as Moody’s and Standard & Poor’s competed to grade a finite pool of debt and gave out inflated stamps of approval to risky assets.

US Fiscal Policy: As we flagged in our Comment yesterday, the Senate last night passed a bill to fund the federal government through January. The bill passed by a vote of 60-40, with nearly all Senate Republicans, seven centrist Democrats, and one Independent voting in favor. It now goes to the House, where the Republicans who control the chamber are expected to pass it, most likely on Wednesday. Once the bill has passed both chambers and President Trump signs it into law, the longest ever government shutdown will end.

• The bill includes full-year funding for the Agriculture Department, military construction, and the legislative branch. The temporary funding for other departments and programs is designed to give legislators time to negotiate and pass full-year funding for them.
• As we noted yesterday, the Democrats who backed the bill also secured language reversing any layoffs of federal workers initiated during the shutdown and guaranteeing back pay. However, they only secured promises from the Republicans for a vote on extending enhanced Affordable Care Act health subsidies by mid-December.

US Air Travel Industry: Transportation officials yesterday warned travelers to expect worsening cancellations and delays this week even if the federal government shutdown ends, as the Federal Aviation Administration rolls out deeper cuts to flights at 40 major airports due to staffing shortages. The major airlines scrapped 2,200 flights yesterday and currently plan to do the same with at least 1,000 flights today.

• Even when the government shutdown ends, the airlines expect it will take days for their systems to normalize.
• That suggests that the air travel industry could suffer a significant financial hit, while overall economic growth could also be slowed.

US Artificial Intelligence Industry: Softbank, the bellwether Japanese technology investor, has reportedly sold its entire 32-million-share stake in AI chip maker Nvidia to help fund its ongoing investments in AI modeler OpenAI. The Nvidia sale raised some $5.8 billion, covering almost one-fifth of Softbank’s expected investment of $30.0 billion in OpenAI this year. The shift signals that at least some sophisticated investors may now be seeing better opportunities in the modelers than in the chip makers who have gained so much from the AI boom to date.

United States-Switzerland: Public and private negotiators from Switzerland are reportedly getting close to a deal with the White House to cut the US’s punishing 39% tariff on most Swiss goods to about 15%, equivalent to the US tariffs on most goods from the European Union. President Trump yesterday said he hasn’t settled on a final Swiss tariff but expected it to be somewhat lower than today. If a deal is eventually reached, it would likely be positive for the broader Swiss economy and its many firms that export heavily to the US.

China-United States: Even though China has begun unshackling its exports of rare-earth magnets as promised in the recent US-China trade truce, the Wall Street Journal today says Beijing is developing a validated end user (VEU) program that would keep US defense contractors from acquiring the products. If implemented, the program could apparently also prohibit the magnets from going to Western aerospace and automotive firms that have both civilian and defense businesses.

• It remains to be seen whether the US would see such a program as a violation of the trade truce. As we have warned previously, the truce could be disrupted at any time, leading to a rekindling of US-China tensions.
• In any case, China’s contemplated VEU system means the US is still at risk of not being able to get the rare-earth magnets needed for key weapons systems such as jet fighters and advanced ammunition. That suggests that the strong US effort to develop rare-earth mines and processing facilities will likely continue, creating opportunities for investors.

European Union: Reflecting Europe’s continued concerns about Russian aggression and other global security risks, the European Commission has begun setting up a central intelligence unit to collate information gathered by the EU member countries’ national spy services and make it more useful to counter joint threats. The new unit will reportedly be staffed largely by officials from the member countries who would be detailed to it on a temporary basis.

Germany: After gaining legislative approval earlier this year to suspend the country’s fiscal “debt brake” and channel 1 trillion EUR ($1.16 trillion) into defense and infrastructure, center-right Chancellor Merz and his government have been accused by two key economic institutes of secretly channeling billions of euros into tax cuts and increased welfare payments. The growing scandal illustrates how Europe’s improved economic prospects in the short term aren’t just tied to defense projects, but to a broader fiscal loosening that includes infrastructure and other pent-up spending.

United Kingdom: In the three months to September, the national unemployment rate rose to a seasonally adjusted 5.0%, above the expected rate of 4.9% and the highest level in a decade, excluding the pandemic period. The rise in joblessness reflects a long period of weak hiring as firms react to the new Labour government’s tax hikes and its vows to boost worker rights. Looking forward, the rise in unemployment also potentially increases the likelihood that the Bank of England will cut interest rates again at its December policy meeting.

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