Major US stock and bond indices were lower this week over US budget deficit concerns earlier in the week, and renewed tariff worries on Friday.
We’ve written before about the need for the federal government to change course from expanding budget deficits back towards the long-term average of 3%. Deficit spending exploded during Covid, which was normal and expected. And while the deficit made it back to pre-Covid levels, it never returned to a sustainable level before growing again.
Sources: Federal Reserve Bank of St. Louis; U.S. Office of Management and Budget via FRED®
The deficit is a simple formula. It’s government revenues (primarily taxes) minus spending. It’s easy to see where the problem lies when we consider that revenues remain near their 50-year average as the deficit is growing.
Through periods of higher tax rates and lower tax rates, government revenues have bounced up and down between 15% and 20% of GDP, averaging 17.4%. We have a spending problem and the spending bill passed by the House of Representatives this week was seen by the markets as another move in the wrong direction. Moody’s downgraded the US government’s credit rating, interest rates spiked higher, and investors sold both stocks and bonds.
“Moody’s didn’t tell us anything we didn’t already know, but they did underscore that things aren’t going in the right direction,” said Kathy Jones, chief fixed income strategist at Charles Schwab. “The ‘big, beautiful bill’ also, when it comes to debt and deficits, is not going in the right direction.”
However, problems at home have created opportunities abroad as international stocks are slightly higher this week and far ahead of US stocks year-to-date.
Emerging markets stocks are in the spotlight again as the “sell U.S.” narrative gained fresh momentum, following Moody’s recent downgrade of the U.S. credit rating.
https://www.cnbc.com/2025/05/22/emerging-markets-next-bull-market-sell-us-market-watchers.html
US bonds found some support Friday as renewed discussions of higher tariffs on the EU sparked investors to sell US stocks and buy bonds.
Through this year’s “dynamic” environment, the US stock market remains remarkably resilient, barely lower year-to-date. Earnings for US companies were surprisingly good in the 1st quarter and investors are hoping profits can remain solid. At this point our tactical risk model remains moderately conservative, recommending the majority of assets invested in cash and bonds with the remainder in foreign stocks for now.
Have a wonderful Memorial Day weekend.
Jack C. Harmon II, CFP®, CIMA
Principal, Harmon Financial Advisors
Registered Principal, Raymond James Financial Services
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