The stock market may focus on Congressional efforts to forge a budget, now that Moody's downgraded the US because of the unchecked outlook for the federal deficit. With the House Budget Committee failing to agree on a budget last week, the question is whether or how will taxes be raised or federal spending cut. Trump presumably will weigh in on the deliberations. From the stock market perspective, the best outcome would likely be skewed toward spending cuts and a reduction in the 10-year projection of the federal deficit. Indeed, the Moody's downgrade could be viewed a market positive for putting pressure on Congress to cut the deficit. Nevertheless, budget-related flareups in the stock market never last. So, a pullback is probably a buying opportunity.
Once the budget issue is resolved, stocks may be supported by expectations of stronger economic growth ahead. Increased business investment and net exports, along with a shift away from imports to domestic production, may turn the consensus outlook away from recession. In such a turn-about the market may begin to consider a tightening as the next Fed policy move. Whatever the Fed's next move, it will not likely be an imminent risk until late this year if at all.
The fear of recession stemming out of Trump's tariffs has abated since he pulled back on the bulk of Chinese tariffs. There will be less of a tax on consumers than what was feared. Moreover, the re-shoring of production by companies and the planned investments in plant and equipment to do so will boost economic activity ahead. And, US exports will be helped by Trump's deals with other countries, such as the 210 Boeing plane order by Qatar, as well as by the recently softer dollar in the FX market.
These boosts to economic activity may not fully boost GDP. They could "crowd out" other sources of demand, if, as is case now, the US economy is operating close to full capacity. Higher longer-term yields would weigh on housing and other interest-sensitive spending. Higher inflation would hurt the consumer.
One US economic data release that could become important to watch is Durable Goods Orders. (April Durable Goods Orders will be released May 27.) They contain information regarding capital spending. It may take several months before they show a pickup in the latter, since the uncertainty and recession fears stemming from Trump's initial tariff announcements likely had businesses pull back in a wait and see posture. A leading indicator of capital spending in the Philadelphia Fed Manufacturing Survey points to a softening in capital spending into the summer before a rebound.
Construction Spending, typically not given much attention by the
markets, will contain information on factory and warehouse building.
These could be a catalyst for growth, as well.
Another important economic data release will be the Trade Deficit. A positive for the US economic outlook would be a speedup in exports and a slowdown in imports. This will be difficult to judge, since both exports and imports surged in Q125 in anticipation of tariffs here and abroad. In 2024, exports rose 2.4% while imports rose 12.2%. In Q125, exports rose 4.6% and imports rose 14.9%. There could be a pullback in both toward longer-term trends in the next quarter or two.
A move toward closing the door on foreign competition, which is what tariffs do, could have an indirect effect on inflation. By shielding US workers from having to compete with lower-paid foreign workers, US labor may increase their wage demands. Fed officials, including Powell, have attributed the benign wage inflation despite lower unemployment to the Fed's success in holding down longer-term inflation expectations. However, it also could have been a result of competition from low-cost labor abroad. And, if the latter eases up, wage inflation may pick up.
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