Ratings

27 May 2025

  Aviva Investors

Aviva Investors: The week in markets - Debt and deficits dominate

Amber Gleeson, Multi-Asset Investment Specialist

US fiscal concerns took centre stage this week, as investors reassessed the long-term sustainability of government debt.  

Read this article to understand:

  • The big stories impacting financial markets this week
  • The immediate aftermath of the passage of the US tax bill
  • Our multi-asset portfolio positioning in the current environment

Market review

Late on Friday May 16, Moody’s Ratings downgraded its US sovereign credit rating, citing rising government debt and a widening budget deficit. The move was widely expected; Moody’s had placed the US on a watchlist in 2023 and was the last major agency to maintain a perfect AAA rating.

Although anticipated, the downgrade came at a sensitive time. Markets are increasingly focused on debt sustainability and the US was in the process of extending a tax bill likely to further increase the deficit. While the downgrade was initially shrugged off by investors, concerns gathered momentum over the week given the potential US tax cuts. 

The bill was passed in the House of Representatives on Thursday May 22, following which the yield on 30-year US Treasuries climbed to 5.14 per cent, extending a rise of more than 0.2 percentage points this week. 

Fears over fiscal sustainability spilled over into global bond markets, sparking a broader bond sell-off. In the UK, this was exacerbated by a surprise uptick in UK inflation, which rose to 3.5 per cent in April, from 2.6 per cent in March and above forecasts of 3.3 per cent.

Concerns about the deficit also impacted US equities; by Thursday’s close, S&P 500 had fallen by 1.9 per cent over the week in US dollar terms. European equity markets were steadier (STOXX 600 increased by 0.4 per cent in local currency terms over the same period), supported by positive geopolitical and trade developments.

These developments included the agreement between the UK and the EU to deepen post-Brexit ties. The UK extended EU fishing rights in exchange for reduced border checks on agricultural exports, a new defence and security pact and a potential youth mobility scheme. Additionally, the EU presented a revised trade proposal to the US, including phased tariff reductions on nonsensitive agricultural and industrial goods, potentially paving the way for renewed trade talks.

Outlook

The outlook from here will hinge on developments in trade negotiations, inflation trends, central bank policy and future corporate earnings. Market volatility is likely to persist as investors assess the broader economic implications of evolving US policy. 

The outcome of the US budget negotiations could have material implications for the US growth outlook in 2026, and investors will watch closely given ongoing fiscal concerns. While first quarter earnings demonstrated resilience, many companies have withdrawn forward guidance for the rest of the year, citing uncertainty. Additionally, the full economic impact of remaining tariffs has likely yet to materialise.

Our positioning in multi-asset portfolios

In portfolios where we have active discretion, we maintain a small overweight allocation to European and emerging market equities, due to improvements in short-term market sentiment.

In equities, we recently introduced an overweight position in UK mid-cap companies relative to UK large caps — a closer relationship with the EU presents an opportunity for mid-caps, which have underperformed large caps for some time.

Within fixed income, we have structured our active positions to be less sensitive to rising bond yields at the long end of the US Treasury curve, favouring exposure at the five-year point. We maintain overweight positions in UK and German government bonds, reflecting our expectation of continued rate cuts from central banks in the regions. We are underweight French government bonds due to a more precarious fiscal situation relative to the rest of Europe and, political instability.

In currency markets, based on our outlook for ongoing dollar weakness, we still have a preference towards the Japanese yen versus the US dollar.

We continue to monitor the situation to ensure the portfolios remain positioned appropriately. While cautious, we are still looking to add value where we have active discretion.

As longer-term investors, it is important to remain calm in these volatile and uncertain times. We remain confident that financial markets can provide the growth required by investors to meet their long-term goals.

References

Source of all data in this article: Bloomberg, as of May 22, 2025.

Key risk 

Investment risk

The value of an investment and any income from it can go down as well as up. Investors may not get back the original amount invested.

Important information

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