Monthly Market Update for May 2025: A Positive Month Despite U.S. Debt Downgrade

June 6, 2025

Sean Gross, CFP®, AIF® | Co-Founder & CEO

Financial markets rebounded in May with the S&P 500 recovering its year-to-date losses. This positive month occurred against a backdrop of new trade agreements, mixed economic signals, and ongoing concerns about U.S. fiscal health. While many reports continued to show that the economy is strong, consumers remained pessimistic about the future. Treasury yields fluctuated throughout the month due to concerns around federal spending and debt. For long-term investors, May serves as a reminder that markets can adapt to changing conditions, even when there is significant uncertainty around economic and fiscal policy.

Key Market and Economic Drivers¹

• The S&P 500 gained 6.2% in May, its best month since 2023, the Dow Jones Industrial Average was up 3.9%, and the Nasdaq rose 9.6%. Year-to-date, the S&P 500 is up 0.5%, the Dow is down 0.6%, and the Nasdaq is down 1.0%.
• The Bloomberg U.S. Aggregate Bond index declined 0.7% in May but is up 2.4% year-to-date. The 10-year Treasury yield ended the month at 4.4%.
• International stocks also performed well with the MSCI EAFE index of developed markets and the MSCI EM index of emerging markets both climbing 4.0%.
• The U.S. dollar index fell further to end the month at 99.3, near a three-year low.
• Bitcoin hit a new record high of $111,092 before ending the month at $104,834.
• Gold also hit a new record high of $3,422 before closing the month at $3,288, a 24% year-to-date gain.
• The Consumer Price Index report released in May showed that consumer prices rose 2.3% in April from a year earlier, the lowest 12-month increase since February 2021.
• The economy added 177,000 new jobs in April while the unemployment rate remained low at 4.2%.

Markets continued to recover despite new concerns

May's market rebound underscores the importance of staying the course during periods of market volatility. After a challenging April, markets demonstrated resilience by recovering most of their losses and returning to positive territory in May. This illustrates how quickly market sentiment can shift when conditions begin to stabilize, a pattern that investors have experienced many times over the past decade. Of course, the past is no guarantee of the future, and markets will continue to worry about trade deals, the U.S. debt, and the health of the economy in the coming months.

Moody's downgraded the U.S. credit rating

One of the biggest surprises in May was Moody's downgrade of the U.S. credit rating from Aaa to Aa1. This followed previous downgrades by Fitch in 2023 and Standard & Poor's in 2011 which all reflect concerns about the nation's growing debt and spending. The accompanying chart shows that the U.S. total debt grew to 122% of GDP in 2024. Net debt, which excludes debt the government owes itself, has risen to 97%.

Despite the historic nature of the U.S. debt downgrade, markets hardly reacted. This is because the downgrade is mostly backward-looking, and investors are already familiar with the nation's fiscal challenges. The muted response also reflects lessons from the 2011 Standard & Poor’s downgrade, when Treasury securities continued to be viewed as safe haven assets.

Perhaps it was not a coincidence that this downgrade occurred as the House of Representatives was passing a comprehensive tax and spending bill. The approved bill would extend the individual tax cuts from the Tax Cuts and Jobs Act. This includes a 37% top rate, child tax credits, higher State and Local Tax deduction caps, and exemptions for tips and overtime pay, among other measures. According to the Penn Wharton Budget Model, the legislation could increase deficits by $2.8 trillion over the next 10 years.² The bill will now be debated and potentially modified in the Senate.

While many would agree that these fiscal challenges require long-term solutions, the U.S. dollar remains the world's primary reserve currency and there will continue to be demand for Treasurys for the foreseeable future.

Trade negotiations show progress

There was also progress on trade negotiations in May, taking many of the worst-case scenarios off the table. The administration reached agreements with both the U.K. and China, while negotiations continued with other major trading partners. The U.S.-China trade agreement included a 90-day period of reduced U.S. tariffs on Chinese goods.

Despite these deals, there will likely continue to be uncertainty around trade. More recently, China and the U.S. have both accused each other of violating the trade truce, and the administration wants higher tariffs on steel and aluminum. At the same time, negotiations with the European Union produced optimism when the White House delayed its scheduled 50% EU tariff after positive discussions. This suggests that diplomatic solutions remain possible, even when initial positions appear far apart.

The administration is also facing legal challenges to its tariffs. In May, the U.S. Court of International Trade struck down many of the newly enacted tariffs, ruling that they exceed presidential power under the International Economic Emergency Powers Act. While a federal appeals court paused the ruling, allowing tariffs to remain in place for now, this legal challenge adds another layer of uncertainty to the trade landscape.

It is important to remember that trade policy typically unfolds over months and years rather than days or weeks. The recovery in May is a reminder that investors should not overreact to trade headlines, especially now that the worst-case scenarios are less likely to occur.

Steady earnings growth supports market

First quarter corporate earnings reports presented another reason for optimism. S&P 500 companies delivered positive earnings per share surprises and 64% reported positive revenue surprises, according to FactSet.³ This strong earnings performance highlighted the underlying health of corporate profitability, with technology companies showing resilience as they navigate trade uncertainty.

In contrast, consumers have been pessimistic this year due to tariffs and inflation concerns. However, recent sentiment indicators began showing signs of improvement that align more closely with positive earnings and economic data. The University of Michigan's most recent survey for May showed inflation expectations decreasing slightly and sentiment stabilizing. While it's important not to read too much into a single month's data, this improvement represents an encouraging development. A strong economy and improving sentiment could help to support markets.

The bottom line? May was a positive month for investors. While the U.S. debt downgrade and fiscal concerns created new challenges, progress on trade deals helped to boost markets. For long-term investors, these developments underscore the importance of maintaining perspective and staying focused on fundamental trends rather than short-term policy headlines.

1Standard & Poor’s, Nasdaq, Bloomberg. All month end figures are as of May 30, 2025.

2https://budgetmodel.wharton.upenn.edu/issues/2025/5/23/house-reconciliation-bill-budget-economic-and-distributional-effects-may-22-2025

3FactSet Earnings Insight May 30, 2025

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Guest Article: Why Keynesians got inflation and growth wrong.

We are delighted to share, with permission, the following article from highly esteemed economist Daniel Lacalle, PhD.1

Inflation is not soaring, and economic growth is solid.

The Tariff Tantrum has proven that consensus was wrong about soaring inflation and an economic slump. Why? The exaggerated perception of tariffs’ economic impact stemmed from the belief that American consumers would bear the full burden of tariffs. Why were they wrong?

The first reason was that most analyses relied on a simplistic calculation of tariffs, treating supply chains as if they only involved buyers and sellers. Supply chains are very complex, and most exporters must deal with overcapacity challenges and working capital problems. Thus, the impact of tariffs is likely to be absorbed by numerous links in the supply chain, including transport, storage, distribution, manufacturing, retailers and purchasing chains.

Furthermore, most exporting companies face a significant problem of overcapacity and working capital; if they don’t sell their products fast and effectively, their debt soars, and the losses at warehouses can lead to a chain of bankruptcies.

Ignoring that the world of exporter businesses, particularly in China, has a structural overcapacity problem and mounting financial challenges due to working capital build was one of the mistakes made by excessively pessimistic analysts. Therefore, there is no sign of inflation soaring anywhere. The Export Price Index rose only 0.1% in April and 2.0% year on year, while the Import Price Index rose a modest 0.1% in the month and 0.1% year on year. Prices dropped by 0.5% in the final demand PPI (producer price index) for April. On a year-over-year basis, headline and core April PPI declined versus previous readings.

United States retail sales rose by 0.1% in April, up 5.2 % from April 2024, and following a large 1.7% increase in March 2025. Inflation hit a four-year low in April, a month that should have reflected a massive increase due to tariffs, according to consensus estimates, while wage growth rose to a four-year high.

Inflation in April slowed to the slowest pace since 2021. Egg prices fell by 12%, and prices for bakery items, meat, and poultry also decreased. Americans are not suffering the apocalyptic inflation that interventionists predicted. The consumer price index (CPI) rose by 0.2% compared to the expected 0.3%—an annualised rate of 2.3%—and the lowest in four years. Furthermore, core CPI rose only 2.8%, showing no sign of inflationary pressures.

The first quarter’s gross domestic product was positive. Despite a 0.3% decline, the private sector increased by 1.6% annually. Government spending declined 5.1%. In the past week, JP Morgan has removed its call for a recession and the Atlanta Fed Nowcast shows a healthy 2.4% GDP growth for the second quarter, an estimate shared by Goldman Sachs and Capital Economics.

The key to understanding the lack of inflation is to look at monetary aggregates. Tariffs do not cause inflation. There are other reasons we can use to criticise tariffs, but not inflation causation. Market participants have realised that tariffs are a tool for negotiating better trade deals and facilitating the opening of markets rather than being used solely as a protectionist measure. The same reason why you need nuclear weapons to avoid a nuclear war: tariffs are required to force better trade deals.

The cause of inflation is the soaring government spending, which leads to an increase in both the money supply and money velocity. Deficit spending is down 35% between February and April 2025 compared to the same period last year. While money supply is rising, albeit at a modest pace, velocity of money is gradually declining. The public sector is slowly shrinking and the private sector is strengthening; hence, there is no real inflation risk.

The only thing that can make aggregate prices rise, consolidate, and continue is the debasement of the purchasing power of the currency due to uncontrolled government spending. Thankfully, government spending is starting to moderate.

The United States economy is stronger than it appears, and the negotiating power of importers is larger than estimated due to two factors: the previously mentioned overcapacity challenge of most exporters and the global relevance of the U.S. market. Exporters cannot substitute their U.S. sales with other markets. Even the European Union is relatively weak as a market.

In the following months, we will likely see more trade deals, and most concerns from market participants will probably vanish or at least be significantly reduced. Ultimately, the Tariff Tantrum has proven that Keynesian analysis is wrong and that successful trade deals were the goal of the administration.

1Daniel Lacalle (Madrid, 1967). PhD Economist and Fund Manager. Author of bestsellers "Life In The Financial Markets" and "The Energy World Is Flat" as well as "Escape From the Central Bank Trap". Daniel Lacalle (Madrid, 1967). PhD Economist and Fund Manager. Frequent collaborator with CNBC, Bloomberg, CNN, Hedgeye, Epoch Times, Mises Institute, BBN Times, Wall Street Journal, El Español, A3 Media and 13TV. Holds the CIIA (Certified International Investment Analyst) and masters in Economic Investigation and IESE.

Guest Article: China’s Keynesian Model Is Crumbling. It Needs a Trade Deal, Fast.

We are delighted to share, with permission, the following article from highly esteemed economist Daniel Lacalle, PhD.1

China’s Keynesian Model Is Crumbling. It Needs a Trade Deal, Fast.

May 11, 2025

In the past decade, the Chinese economy has expanded its central-planned neo-Keynesian model that simply cannot survive without a trade deal. The Chinese manufacturing sector has followed a running-to-stand-still strategy that simply cannot subsist without the enormous trade surplus with the United States.

The Chinese manufacturing sector overcapacity is not an anecdote. It is the norm. China produces 30% of the world’s manufacturing goods but consumes less than 18%, according to CKGSB. Additionally, China’s industrial capacity utilization rate fell to 74.1% in the first quarter of 2025.

China’s Keynesian central planning model aims to maximise employment and maintain strong economic growth, despite financial constraints and excessive indebtedness. Thus, it needs to sell its excess production to avoid a massive problem of working capital. Even the government has recognised the problem in a roundabout way, noting that “involution”-style competition (wasteful competition) is a major focus for the 2025 economic policy, and steps are being taken to reduce unnecessary investments and control growth in some industries. However, overcapacity in China is not a fatality; it was created by political design, with local and national authorities trying to boost GDP at any cost.

The model is aimed at keeping full employment and economic growth even with economic returns below the cost of capital, and it almost works if the excess capacity can be sold globally, receiving reserve currency and maintaining low costs by passing the working capital cost to global consumers and maintaining low production expenditure with currency controls and exchange rate fixing. However, the combination of rising debt, a constantly weakening currency, and the escalating bankruptcy and working capital issues could potentially bring this model to a collapse, even in the absence of an official recession.

China has learnt that it cannot endure a trade war and cannot substitute the US consumer, the richest and largest market, with European or Latin American consumers. Therefore, it needs a trade deal quickly before the domino of bankruptcies that has plagued the Chinese economy since 2021 erupts into a full-blown financial crisis.

China is officially in deflation for the third consecutive month in April. Business insolvencies are projected to increase by 7% in 2025 and by 10% in 2026, according to Allianz, even as the government implements additional fiscal stimulus.

Small and medium-sized enterprises, particularly exporters, are facing mounting bankruptcies due to declining cash flow and the elimination of US tariff exemptions. Job losses are rising in export-dependent regions, and the urban unemployment rate is expected to average 5.7% in 2025, above the official target, according to CNBC.

The official NBS Manufacturing PMI fell sharply to 49.0 in April 2025, the steepest decline since December 2023, reflecting a drop in output, new orders, and employment, with foreign orders shrinking to their lowest in at least eleven months.

The collapse of the real estate sector, which once accounted for up to 30% of GDP, has weakened banks, reduced household wealth, and led to a negative wealth effect, further depressing consumption and credit demand.

China’s economic strengths are well known, but the weaknesses are too important to ignore. The situation serves as a reminder that central planning never works. Everything that is weak in China comes from previous years of government policies aimed at boosting economic growth by building stuff and hoping it would sell at some point. Furthermore, rising bankruptcies, an imploding property market, and mounting local government debt strain the financial system just as non-performing loans from the Belt and Road Initiative (BRI) soar. Several BRI countries have defaulted on their debts or required IMF bailouts, including Sri Lanka, Zambia, Ghana, and Pakistan, while the BRI generated $385 billion in off-the-books debt.

Keynesian policies always lead to high debt and stagnation. However, when combined with a centralised planning system, a closed financial system, and capital controls, Keynesian policies create a dangerous mix of overcapacity, poverty, and economic slack. China can only begin to address its enormous working capital problem through a quick and successful trade deal with the United States. It will benefit China enormously if the government opens its economy, lifts capital controls, and allows the private sector to breathe. An implosion of the overcapacity problem hidden from the media, offset by even more central planning and stimulus spending, is only going to weaken China in the long run.

1Daniel Lacalle (Madrid, 1967). PhD Economist and Fund Manager. Author of bestsellers "Life In The Financial Markets" and "The Energy World Is Flat" as well as "Escape From the Central Bank Trap". Daniel Lacalle (Madrid, 1967). PhD Economist and Fund Manager. Frequent collaborator with CNBC, Bloomberg, CNN, Hedgeye, Epoch Times, Mises Institute, BBN Times, Wall Street Journal, El Español, A3 Media and 13TV. Holds the CIIA (Certified International Investment Analyst) and masters in Economic Investigation and IESE.

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Guest Article: Container Orders Plummet. Trade Deals Now or Economic Depression Soon.

We are delighted to share, with permission, the following article from highly esteemed economist Daniel Lacalle, PhD.1 

Container Orders Plummet. Trade Deals Now or Economic Depression Soon.

April 20, 2025

Global container booking volumes fell by 49% between the last week of March and the first week of April 2025, according to Freight Waves. Imports from China to the United States collapsed by 64%, with imports of apparel and textiles declining by a whopping 59% and 57%, respectively. The figures coming from shipping companies are worse than those seen during the Covid-19 crisis.

These alarming figures suggest that importers are unwilling to accept higher prices in the middle of a tariff war, that exporters cannot simply choose to move their products elsewhere easily, and that the excess capacity in many sectors is much larger than initially expected.

No one wants to accept the cost of tariffs, and this means that the only option for the economies with elevated productive overcapacity is to negotiate a trade deal, and quickly, or face an economic depression.

The mainstream view about tariffs was that United States consumers would pay the entire negative impact. This news suggests otherwise. The purchasing power of importers is higher than expected. The number of order cancellations is so large that ports in China have had to take emergency measures to address the challenges created by piles of unsold containers.

The negative impact is enormous on ports, as fees plummet, but we cannot forget the dramatic effect on producers with excess capacity. Many global exporters are going to face bankruptcy if no trade deal is reached due to insufficient working capital.

In the European Union, leaders are concerned that the trade war between the United States and China will bring a flood of cheap products from China that could endanger local producers and create a significant economic problem.

Many exporters are facing a harsh reality: They cannot sell their products if they don’t export them to the United States, and the importers are not going to accept higher prices due to tariffs.

The reason why exporters cannot pass the cost of tariffs to United States consumers is because most of the products they delivered to America were only attractive because they were exceedingly cheap. When prices rise, demand decreases significantly. The tariff war has shown that demand is not inelastic.

The collapse in container orders proves Menger’s imputation theory. Output prices determine factor prices, not the other way around.

The unsustainable state of global shipping will compel countries to expedite trade agreements with the United States, failing which they risk a cascade of economic collapses within their business structures.

The slump in container orders proves that United States importers are not going to accept any price, that excess capacity in the main retail sectors is enormous, and that there is no straightforward alternative for American consumers.

If you believed that other countries would hesitate to negotiate trade agreements with the United States, you need to reconsider.   The American consumer loves cheap products but does not want the same goods at twice the price.

The United States economy may suffer a contraction due to this sudden slump in imports, but the consequences are much larger for the exporter nations.

The outcome is not positive for any country, so there is only one choice to make: negotiate or lose. If countries fail to establish significant trade agreements with the United States in the near future, their retailers are likely to face a severe working capital crisis.

1Daniel Lacalle (Madrid, 1967). PhD Economist and Fund Manager. Author of bestsellers "Life In The Financial Markets" and "The Energy World Is Flat" as well as "Escape From the Central Bank Trap". Daniel Lacalle (Madrid, 1967). PhD Economist and Fund Manager. Frequent collaborator with CNBC, Bloomberg, CNN, Hedgeye, Epoch Times, Mises Institute, BBN Times, Wall Street Journal, El Español, A3 Media and 13TV. Holds the CIIA (Certified International Investment Analyst) and masters in Economic Investigation and IESE.