The fiscal cliff is approaching. Is "selling America" about to make a comeback?

Source: Jin10

The deteriorating fiscal situation in the United States is threatening the positive atmosphere on Wall Street.

Investors sold U.S. government bonds and dollars on Monday after Moody’s stripped the U.S. of its last AAA credit rating on Friday, citing a massive budget deficit and rising interest costs. Even more concerning, the House Budget Committee passed a tax and spending bill on Sunday that is expected to increase the deficit by trillions of dollars.

Although the stock market closed higher, selling activity pushed up the yields on long-term U.S. Treasuries (yields rise when bond prices fall). The yield on the 30-year U.S. Treasury briefly surpassed 5%, ultimately just below this threshold, but still close to the highest level of the year.

The yield on U.S. Treasury bonds has continued its upward trend for several weeks, driven by weakening concerns about an economic recession, ongoing worries about inflation, and increasing anxiety that larger deficits will lead to larger bond issuances. The increase in U.S. Treasury supply may outpace demand, forcing the government to pay higher interest rates to attract investors.

The recent scale of the budget deficit has particularly shocked investors. This is because these deficits occur during periods of economic strength, rather than during economic downturns (typically, during economic recessions, tax revenues plummet, and the government increases spending to stimulate growth and help the unemployed).

Christopher Sullivan, Chief Investment Officer of the United Nations Federal Credit Union, questioned: “If we can have such a large deficit now, what will happen when the economy really gets into trouble?”

According to Tradeweb data, the 30-year U.S. Treasury yield closed at 4.937%, higher than the 4.786% at the end of last year. The 10-year U.S. Treasury yield closed at 4.473%, higher than last Friday’s 4.437%, and also above the less than 4.2% at the end of April.

The rise in US Treasury yields has hardly slowed down the stock market’s gains. After the Trump administration withdrew some aggressive tariff policies and investors’ concerns about an economic recession eased, the stock market has rebounded in recent weeks.

Nevertheless, investors are still closely watching U.S. Treasury yields, as they play an important role in determining the borrowing costs for the entire economy. The S&P 500 index rose 0.1% on Monday, the Dow Jones Industrial Average increased by 0.3%, while the tech-heavy Nasdaq Composite index remained flat.

As we enter this year, many analysts believe that one of the biggest risks facing the U.S. stock market is —— if the Republican Party implements tax cuts without offsetting their costs, U.S. Treasury yields could soar.

These concerns temporarily took a back seat after Trump announced significant tariff increases on April 2, as the market immediately feared that the economy might fall into recession. However, recently, even before Moody’s downgraded its rating, these concerns resurfaced, and the long-awaited tax reduction legislation has taken shape in Congress.

After the latest hurdle last Sunday, the U.S. House of Representatives is expected to vote on a proposal as early as this week that would extend the upcoming expiration of tax cuts, add some new tax cuts, and reduce spending on Medicaid and nutritional assistance. Compared to the scheduled expiration of the tax cuts on December 31, the proposal is expected to increase the budget deficit by about $3 trillion over the next decade.

There has been a long-term imbalance between U.S. spending and tax revenue. The publicly held federal debt is approximately $29 trillion, almost twice what it was when Trump signed the initial tax cut policy in 2017. Nearly $1 of every $7 spent by the U.S. goes towards paying interest, which exceeds defense spending.

Fiscal issues may revive the “Sell America” trades that appeared last month, when investors were concerned that isolationist trade policies could lead to a global capital war, resulting in foreign investors selling American assets, including U.S. Treasuries.

"This further fuels the ‘sell America’ trade, and you’ve already seen this reflected," said Michael Arone, chief investment strategist at State Street Global Advisors.

“Investors are watching for changes in policy; they are also monitoring changes in interest rates,” Aroney said. “This uncertainty is unsettling, and I believe this is exactly what the market ultimately reflects.”

Several investors have pointed out that concerns over the US fiscal situation have troubled investors for years, but have not caused lasting disruptions to the stock market. They indicated that factors such as changes in trade policy are more likely to affect the market in the short term.

Kevin Gordon, Senior Investment Strategist at Charles Schwab, stated: “The market doesn’t know what to focus on; it must constantly shift. Tariffs may still be at the top of this list.”