The Rhino Report - Debt Concerns and Tariff Uncertainty Drive Market Volatility

The S&P 500 finished the week down 2.61% on concerns over the debt level and continuing tariff uncertainty. Markets had little reaction to the Moody's downgrade of US credit on May 16 until 1pm on Wednesday, when the 20-year Treasury auction revealed weak investor demand. I wrote about this downgrade in a separate blog post. Market volatility continued, as the week ended with more questions than answers on tariffs and trade policy.

When consumers apply for credit, whether it be for a credit card or a mortgage, the lender pulls a credit report from one of three credit reporting agencies: Equifax, TransUnion, or Experian. When a company, municipality, or sovereign government issues debt, its credit rating is provided through one of three credit rating agencies: Moody's Investor Services, Standard & Poor's (S&P Global), and Fitch Ratings. Moody's was the last of the three to downgrade US debt to below AAA. Not unlike a consumer, when a company, municipality, or sovereign government has less than pristine credit, they may be subject to paying a higher interest rate on the money they want to borrow. On Wednesday, the U.S. Treasury auctioned $16B in 20-year Treasury Bonds, essentially applying for loans from bond investors. Bond investors demanded higher interest rates. Higher bond yields create competition for stocks, and the stock market declined.

Blog Post: US Debt Downgrades: What You Need to Know

The U.S. House of Representatives passed HR1 "The One Big Beautiful Bill Act" on Thursday, May 22 by a narrow 215-214 vote. Markets were expecting some budget cuts and some measure of fiscal austerity to address the mounting debt concerns, but instead got a package that could add $3.3 trillion to deficits over the next decade. The bill extends Trump's 2017 tax cuts, raises the debt ceiling by $4 trillion, and includes only modest spending reductions primarily focused on safety net programs like Medicaid and SNAP. Rather than the fiscal restraint bond investors were hoping for, the legislation essentially doubles down on deficit spending while the Treasury is simultaneously struggling to find buyers for its debt at reasonable interest rates.

Thursday morning, the Department of Labor released the weekly jobless claims report. At 227,000, we are not seeing any meaningful increase in jobless claims, though continuing claims ticked higher to 1.903M. This suggests that there wasn't a spike in people filing for unemployment insurance, but those who are unemployed are finding it more difficult to find new employment. Employers aren't necessarily laying people off, but the pace of hiring has slowed.

Friday morning, President Trump shocked the markets with social media posts suggesting a 50% tariff on products from the European Union starting June 1 and warning that smartphones would face at least a 25% tariff unless manufactured in the United States. The announcements came via social media posts, catching investors off guard just as they were processing the week's earlier concerns about debt and deficits. The proposed EU tariff represents a significant escalation from the current 20% rate, while the smartphone tariff threat directly targets the tech industry's China-based manufacturing. U.S. futures turned negative as traders worried about retaliation and the potential for renewed trade wars. However, as the day progressed, markets recovered some of the early losses. It could be that our President has changed his mind enough times that investors are giving bombastic policy threat statements less weight.

People have been saying that the trajectory of U.S. fiscal policy deficits and debt is unsustainable. By definition, that which is unsustainable cannot continue indefinitely. Part of the problem is our short election cycles, which cause politicians to care more about keeping their jobs than doing their jobs. Our politics have devolved into adversarial teams that spend money to appease specific groups of constituents or advance partisan agendas, rather than working together to build consensus around tackling big problems.

If Congress raised our taxes to cover their spending, there would be public outcry, and the economy would grind to a halt, so they continue spending and pushing the bill to future generations. There is an old saying: "don't tax you, don't tax me, tax that rich guy behind the tree." There aren't enough rich guys to cover this, and we're past the point of growing our way out of debt. What I fear is that the alternative is to inflate our way out of debt.

The Big So What? Everyone wants to know when the next recession will come and reset our economy because that's the pain people remember. Many of the traditional recession indicators have failed us in recent years. Policy uncertainty has increased the risk of recession, but it's not apparent that one is on the horizon. I expect the economy may slow in response to the tariff uncertainty and the eventual drag on corporate earnings, but a deep recession requires a rise in unemployment, so watch the four-week moving average of weekly jobless claims that I monitor regularly. I would be concerned if that number rises above 250,000. You should prepare for the possibility of interest rates remaining above the low rates we've become accustomed to and for persistent inflation. Markets don't like uncertainty, but they're remarkably good at adapting to new realities. The key is staying disciplined and not letting short-term noise derail long-term objectives.

By The Numbers

Employment Indicators

Employment data helps gauge whether consumers have jobs and money to spend. Consumer spending accounts for more than 70% of GDP.

Indicator	Current Value	Status
Initial Claims for Unemployment	227,000	Stable
4-Week Average of Initial Claims	231,500	Caution
Continuing Claims	1.903M	Elevated
Unemployment Rate	4.2%	Stable

Note: Values above 250K for the 4-Week Average, combined with rising unemployment, would signal a weakening economy. Next unemployment report: June 6, 2025. Source: Department of Labor

Economic Growth (Real GDP)

Period	Growth Rate	Status
Q3 2024	2.8%	Positive
Q4 2024	2.3%	Slowing
Q1 2025	-0.3%	Contraction
Q2 2025 (est.)	2.4%	Projected Recovery

GDP growth provides a broad measure of overall economic activity and signals whether the economy is expanding or contracting.
Source: Bureau of Economic Analysis; Q2 estimate from Federal Reserve Bank of Atlanta

Inflation Measures (CPI Year-over-Year)

Month	Rate	Trend
June 2024	2.98%	-
July	2.89%	Improving
August	2.53%	Improving
September	2.44%	Improving
October	2.60%	Deteriorating
November	2.75%	Deteriorating
December	2.89%	Deteriorating
January 2025	3.00%	Deteriorating
February	2.82%	Improving
March	2.39%	Improving
April	2.31%	Improving
May (est.)	2.40%	Deteriorating

Source: Bureau of Labor Statistics; May estimate from Federal Reserve Bank of Cleveland

Note: While inflation has moderated, new tariffs may cause temporary spikes in monthly data. Once tariffs have been in place for a full year, inflation should revert closer to the underlying trend.

Interest Rate Outlook

Current Fed Funds Rate: 4.25-4.50%

Expected Cut Date	Amount	Projected Rate After Cut
September 17, 2025	0.25%	4.00-4.25%
December 10, 2025	0.25%	3.75-4.00%
March 18, 2026	0.25%	3.50-3.75%
July 29, 2026	0.25%	3.25-3.50%

Note: Changes in monetary policy expectations reflect market participants' views on how the Fed will likely respond to shifts in inflation or employment.
Source: CME FedWatch Tool

Corporate Earnings Outlook (S&P 500 Estimates for 2025)

Date	Earnings Estimate	Trend
June 28, 2024	$276.29
Sept 30, 2024	$274.73	Deteriorating
Dec 31, 2024	$271.25	Deteriorating
Mar 31, 2025	$266.39	Deteriorating
Current	$257.92	Deteriorating

Source: S&P Dow Jones Indices

Market Valuation

Metric	Value	Assessment
Current S&P 500 P/E ratio	22.50	Expensive
Historical P/E (pre-1980)	14.0
Historical P/E (post-1980)	19.0

Note: Equity valuations remain expensive by historical standards.