May 24, 2025 Market Update

Stocks pulled back last week after tepid demand at a $16 billion auction of 20-year Treasury bonds reignited concerns about the nation’s growing fiscal deficit.  The federal government issues Treasury bonds to service its debt, and it’s looking increasingly unlikely that Washington will take the politically unpopular steps needed to bring deficits under control anytime soon.  

Bond market participants are growing more concerned that a steady rise in government bond issuance could overwhelm demand, pushing bond prices lower and yields higher.  Yields on 30-year U.S. Treasury bonds surged above 5% last week, reaching levels not seen since 2023, and before that, not since 2007 shortly before the great financial crisis.

Higher yields pose another headwind for equities.  As bonds become more attractive, they put downward pressure on stock valuations.  Even so, the outlook for stocks isn’t entirely negative.  Corporate earnings remain the most important driver of equity performance over the long term.  Increased government spending, rising wages, productivity gains, and continued innovation could all contribute to stronger earnings growth in the months ahead.

The federal government is currently running annual deficits in the ballpark of $2 trillion—more than 6% of GDP—with little political appetite on either side of the aisle to reverse course.  New tax and spending proposals could widen the gap further in the years ahead.

Investors received another reminder of the impact America’s fiscal policy is having on financial markets when Moody’s Ratings downgraded the U.S. government’s credit outlook, citing persistent deficits and a rapidly rising national debt now approaching $37 trillion.  With this move, all three major credit rating agencies now place the U.S. below the coveted triple-A level.

While the downgrade doesn’t suggest an immediate crisis, it’s an important reason for investors to reconsider their expectations for long-term returns in U.S. stock and bond markets.  Perhaps more importantly, mounting debt could eventually limit the government’s flexibility to respond to future economic shocks.  In an era where interest rates are no longer near zero, the cost of servicing that debt is becoming an increasingly important factor for both policymakers and markets to reckon with.

That’s all for now.  Have a great weekend and invest wisely my friends.