Market Review
Right back to where we started
In May, the market rebound that began in the back half of April was extended, as peak tariff policy uncertainty continued to abate. Broadly, global equities experienced monthly gains, with U.S. large cap growth leading performance. The S&P 500® returned 6.2% and the Nasdaq Composite® Index returned 9.6%, both the highest respective monthly index returns since November 2023. This helped to catapult year-to-date performance back into positive territory (Figure 1).
Figure 1. S&P 500 Price Levels
The index ended May near levels at the start of the year.
As of 5/31/2025. Source: Bloomberg L.P.
View accessible version of this chart.
The impetus for the rally was a familiar theme - de-escalation in the implementation of tariff policy. The mid-month de-escalation of U.S./China trade tensions and the month-end delay in U.S./European Union tariffs were the major market movers. Though we appear to be past peak domestic uncertainty, evolving tariff policy remains a key driver of equity markets.
The bond market, however, told a different story in May. Bond returns were mostly negative for the month, the Barclays Aggregate Bond Index returned -0.72% as U.S. Treasury (UST) yields increased. On the longer end of the yield curve, the closely watched 10-year UST yield increased to 4.60% during the month, as investor concern shifted from tariffs to the federal budget deficit. Despite the rise in UST yields, below-investment grade bonds maintained their higher correlation to equity markets and delivered positive returns for the month, as credit spreads recovered from their spike in April.
Theme of the Month
Your move, Mr. Bond
In May, Moody’s Ratings joined the other two major credit rating agencies (Standard & Poor’s and Fitch Ratings) in downgrading the U.S. government’s credit rating to Aa1 from Aaa, one step below their highest tier of investment grade credit ratings. The rationale behind the ratings action was nothing new: the U.S. government continues to run large annual fiscal deficits, which are now accompanied by growing interest burdens.
The deficit also returned to the spotlight due to The One, Big, Beautiful Bill passing in the House of Representatives, which, by Congressional Budget Office estimates, could increase the federal debt by $2.4 trillion over 10 years and keep annual fiscal deficits to more than 6% of GDP (Figure 2). Notably, that estimate does not include any potential offsetting tariff revenue, since tariff policy is constantly changing and there are no guarantees about which tariffs will remain in place beyond the current administration.
Figure 2. U.S. Fiscal Deficit/Surplus
Large U.S. budget deficits have persisted since the 2008 Global Financial Crisis
As of 5/31/2025. Source: Bloomberg L.P.
View accessible version of this chart.
An increasing fiscal deficit requires increasing UST issuance to fund the deficit, and in May, the bond market reacted to these developments by selling off and sending yields higher, particularly in bonds with longer-dated maturities. The 10-year UST yield, of note due to its use as a benchmark for consumer credit, neared year-to-date highs on the month.
Since month end, yields have moderated but overall, have remained in a 4% to 5% range since early October when the Federal Reserve began cutting short-term rates. The long end of the yield curve came under increased scrutiny after the 30-year UST yield breached 5% towards the end of the month, approaching the highest level in 18 years. Several tepid long-dated UST auctions last month, particularly for 20- and 30-year maturity Treasury bonds, also put the current demand for the large supply of U.S. government debt into question.
While those yield levels may seem elevated due to the low-interest rate environment characterizing 2009 through 2022, they remain well below levels seen in the 1990s and early 2000s (Figure 3). A normalization of interest rates may not necessarily be a bad thing, but sharp moves in long-term yields warrant investigation, in our view. As of this writing, the climb higher seems to be on pause, but there appears to be some evidence that the bond market will serve as a guiderail for fiscal policy.
Figure 3. Historical 10-year and 30-year UST Yields
Longer-dated Treasury yields remain well below levels in the late 1990s and early 2000s
As of 5/31/2025. Source: : Bloomberg L.P.
View accessible version of this chart.
Does this mean investors should conjure images of bond vigilantes riding again? In our view, we are not on the precipice of major economic issues caused by deficits or movements in the bond market, and we do not see evidence of significant dumping of USTs by large foreign governments or other investors. Though we believe the current trajectory of fiscal deficits is not sustainable in the long term, there have been numerous examples of the U.S. and other major developed countries functioning in the shorter term amid high deficits, without culminating in a crisis. We expect investors will continue to focus on bond yields while the tax bill is negotiated, before deemphasizing it in the second half of the year.
One bond market metric we track closely is high yield credit spreads, which measure the yields of corporate bonds rated below investment grade compared to UST yields. As the worst-case scenarios for tariff policy dissipated throughout May, spreads returned to the tight levels last seen in March. This retracement signals to us that overall credit fundamentals are healthy and that investor willingness to take risk may have been rattled but is not broken. While policy uncertainty remains high and additional market disruptions are likely to occur, we believe the resiliency of the U.S. economy, supported by its size and the reserve currency status of the U.S. dollar, is also quite formidable.
For more information, please contact your PNC advisor.
Figure 1: S&P 500 Price Levels (view image)
The index ended May near levels at the start of the year.
Date |
Cboe Volatility Index |
12/2024 |
5881.63 |
1/2025 |
6040.53 |
2/2025 |
5954.5 |
3/2025 |
5611.85 |
4/2025 |
5569.06 |
5/2025 |
5911.69 |
As of 5/31/2025. Source: Bloomberg L.P.
Figure 2: U.S. Fiscal Deficit/Surplus (view image)
Large U.S. budget deficits have persisted since the 2008 Global Financial Crisis
Year |
Value of Initial Investment of $10,000 |
1990 |
-3.95% |
1995 |
-1.88% |
2000 |
2.442% |
2005 |
-2.415% |
2010 |
-8.329% |
2015 |
-2.58% |
2020 |
-15.17% |
2025 |
-6.758% |
As of 5/31/2025. Source: Source: Bloomberg L.P.
Figure 3: Historical 10-year and 30-year UST Yields (view image)
Longer-dated Treasury yields remain well below levels in the late 1990s and early 2000s
Date |
U.S. Treasury 10-year Yield |
U.S. Treasury 30-year Yield |
1997 |
6.7% |
6.9% |
2001 |
5.4% |
5.8% |
2005 |
4.0% |
4.3% |
2009 |
3.5% |
4.3% |
2013 |
2.1% |
3.3% |
2017 |
2.2% |
2.9% |
2021 |
2.8% |
3.0% |
2025 |
4.4% |
4.9% |
As of 5/31/2025. Source: Bloomberg L.P.
