Published May 30, 2025
We have been in business for almost 25 years now. Throughout that time, investors have consistently expressed concerns about the levels of U.S. government debt, with no real action taken by Congress or any Administration.
As the government wrestles with this year’s budget and the resulting increase in debt, the topic is once again in the news. To further ratchet up the intensity, Moody’s recently downgraded U.S. credit (the last major credit agency to do so). A disappointing treasury bond auction, both in the U.S. and in Japan (for their debt), created more concern.
Delta Research provides further overview information on the topic below. The debt has not been a problem so far. At some point, economists expect that will change and the country will face an economic reckoning. There will likely be no warning for this tipping point, just a sudden series of poorly received debt auction leading to higher interest rates and increasing calls for Congressional and Administration action.
Here is Delta’s overview:
“Moody’s downgraded U.S. sovereign debt because they are increasingly concerned with the trajectory of our deficit spending and the roughly $36 trillion of outstanding debt. Since Covid, interest expense on U.S. debt has doubled. Net interest payments are now the second-largest line item in the U.S. federal budget, trailing only Social Security.
Debt expense is crowding out other government expenditures and may reach a point whereby the only solution is to substantially reduce entitlement spending and raise taxes.
Because of the increased debt financing requirement, the government interest expense burden has become highly sensitive to interest rate changes. Rising interest rates significantly exacerbate the high level of interest expense. The U.S. 10-year treasury yield is a benchmark for government borrowing costs. It is also a key driver in many consumer loans including mortgage and car loan rates.
The 10-year U.S. treasury rate has risen from about 3.9% to 4.6% in the past two months.
A treasury bond auction this week on Wednesday experienced relatively soft demand compared to the prior 12 auctions. The reconciliation bill passed by the House of Representatives this week is expected to add $3.3 trillion to deficits over the next ten years. Rising borrowing requirements versus a backdrop of softening demand suggest 10-year rates may remain relatively high or move higher even if the Federal Reserve lowers the short-term Fed Funds rate.
Predicting future 10-year bond yields is notoriously difficult. Higher interest rates increase the discount rate of future earnings lowering the present value of stocks. However, interest rates are only one input to stock valuation. In the first quarter, S&P 500 companies collectively reported 4.4% revenue growth year-over-year and 12.6% earnings growth. The Magnificent 7 companies reported 28% year-over-year earnings growth. Corporate stock buybacks surged 24% year-over-year to about $272 billion. Those positive earnings reports have helped justify the market’s recent recovery. However, rising interest rates remain a headwind for stocks.
Market Update
Stocks kicked off the holiday-shortened week Tuesday with strong gains in a decidedly risk-on day as President Trump deferred imposition of tariffs on European goods. The Nasdaq 100 (QQQ) popped +2.5% with Tesla gaining +7% on news that Elon Musk would be stepping down from his government advisory role (aka DOGE) to focus on his businesses. Stocks gave back -0.5% Wednesday after minutes from the Fed’s latest meeting spotlighted their ongoing inflation concerns. Investors also showed a little caution waiting for Nvidia’s earnings report after the market close. The AI leader and semiconductor maker posted another stellar quarter sending the company’s stock price +5% at the open Thursday. However, investors pared the gains throughout the Thursday session as Best Buy cut their outlook citing economic uncertainty. After the close, however, retail heavyweight Costco posted strong results in a counter to Best Buy’s warning. Friday saw investors selling through the morning session before rallying back in the afternoon to leave indexes little changed on the day.
Stocks managed to hold on to the gains from the beginning of the week as the market continues to digest the change in character from the positive leap two weeks ago. The S&P 500 recovered most of the prior week’s losses with a +1.78% finish. The Nasdaq 100 (QQQ) gained +1.94% with all of the Mag 7 earnings reports now posted for the quarter. Small caps continue to underperform on a relative basis rising +1.24% this week and remaining below its long-term 200-day trendline.
Warm wishes and until next week.