US markets rattle amid fiscal concerns

[UNITED STATES] U.S. financial markets faced renewed turbulence this week as long-term Treasury yields surged to their highest levels in 18 months, triggering a sharp sell-off in stocks and raising alarms about the country’s fiscal trajectory. Investors are increasingly concerned that Washington’s latest tax and spending proposals could add trillions to the national debt, eroding confidence in U.S. assets and threatening the stability of global markets.

Market Reaction: Bonds and Stocks Under Pressure

The bond market’s anxiety was on full display following a lackluster $16 billion auction of 20-year Treasury notes, which saw the highest yield since the bond’s reintroduction in 2020. The 30-year yield jumped over 10 basis points, reaching as high as 5.1%, while the 10-year yield climbed to approximately 4.61%. This spike in yields reflects investors’ growing reluctance to lend to the U.S. government amid fears of unsustainable deficits.

Stock markets responded with their worst session in a month. The S&P 500 lost 1.6%, the Dow Jones Industrial Average fell by more than 800 points, and the Nasdaq Composite dropped 1.4%. Analysts warn that elevated yields make it harder to justify the high valuations currently seen in equities, increasing the risk of further declines.

“These higher yields make it much tougher to justify today’s very high valuation levels,” said Matt Maley, chief market strategist at Miller Tabak.

The impact of rising yields extends beyond the stock market, affecting other sectors of the economy as well. Higher borrowing costs for the government can lead to increased interest rates for businesses and consumers, potentially slowing economic growth. This is especially concerning as the U.S. economy is still recovering from the effects of the COVID-19 pandemic, with many businesses still struggling to regain their footing.

Fiscal Outlook: Deficit Concerns Dominate

At the heart of the market’s unease is the debate over President Donald Trump’s proposed tax legislation, which is expected to be voted on in Congress this week. The plan, which aims to extend and expand tax cuts from Trump’s first term, could add approximately $3.8 trillion to the existing $36 trillion U.S. debt pile over the next decade. This prospect, combined with persistent budget deficits projected to remain above 6% of GDP, has intensified scrutiny of America’s fiscal health.

The situation worsened after Moody’s downgraded the U.S. credit rating, citing the government’s growing challenge in funding its expanding deficit. The downgrade has fueled a “Sell America” narrative, with investors seeking alternatives outside the U.S. and the dollar hovering near a two-week low against major currencies.

Historically, credit rating downgrades have had significant impacts on investor sentiment and market behavior. While the immediate effects of such downgrades can vary, they often lead to increased borrowing costs and reduced confidence in the affected country’s financial stability. In the case of the U.S., the downgrade by Moody’s has heightened concerns about the long-term sustainability of the national debt, particularly as the government continues to grapple with rising healthcare and social security costs.

Broader Implications: Global and Domestic Risks

The rise in Treasury yields is not just a domestic concern. Higher U.S. borrowing costs can ripple through global markets, raising interest rates for consumers and businesses worldwide. Analysts at Morgan Stanley and Deutsche Bank warn that if yields remain elevated, they could pressure stock valuations further and potentially trigger renewed volatility.

Foreign investors, who play a crucial role in financing the U.S. deficit, are showing signs of hesitation. “At the core of the problem is that foreign investors are simply no longer willing to finance US twin deficits at current level of prices,” said George Saravelos, global head of FX research at Deutsche Bank.

The reluctance of foreign investors to continue financing the U.S. deficit could have far-reaching consequences. As the largest economy in the world, the U.S. relies heavily on foreign capital to fund its budget shortfalls. If foreign investors pull back, it could lead to a sharp increase in interest rates, further destabilizing the global financial system. This is particularly relevant given the current geopolitical tensions and the ongoing trade disputes that have already strained international economic relations.

Political Stalemate and Economic Uncertainty

The political debate in Washington has only added to the uncertainty. Some Republican lawmakers are resisting Trump’s tax bill unless it includes provisions for state and local tax deductions, while the White House is urging quick passage, warning that failure would be the “ultimate betrayal”. Former Treasury Secretary Steven Mnuchin called for urgent fiscal repair, stating, “The budget deficit is a larger concern to me than the trade deficit. So I’m on the side of, I hope we do get more spending cuts — something that’s very important”.

Outlook: What’s Next for Markets?

With the U.S. debt-to-GDP ratio now at 123%, up from 104% in 2017, and fiscal risks showing no sign of abating, investors are bracing for continued volatility. The Federal Reserve’s cautious approach to interest rate cuts and the uncertain fate of the tax bill in Congress add further complexity to the outlook.

“We expect fiscal and deficit risks to linger as budget proposals imply the deficit will stay above 6%, despite a strong economy, and equity valuation is nearly double its 2011 level when S&P cut the US rating with a post-financial-crisis deficit above 8%,” said Stuart Kaiser, head of US equity trading strategy at Citigroup.

The combination of fiscal uncertainty and market volatility presents a challenging environment for investors and policymakers alike. As the U.S. navigates these complex issues, the need for a coherent and sustainable fiscal strategy becomes increasingly urgent. Failure to address the growing debt and deficit could lead to long-term damage to the U.S. economy and its standing in the global financial community.

The latest surge in Treasury yields and the accompanying sell-off in stocks underscore the fragility of investor confidence in the face of mounting U.S. fiscal challenges. As Congress debates the future of tax and spending policy, markets will remain on edge, watching closely for signs of fiscal discipline—or further deterioration.