U.S. Deficit Crisis Deepens Market Divide! Goldman Sachs Warns: U.S. Debt and Dollar Face Pressure, U.S. Stock Resilience on Display

Gao Sen (Goldman Sachs) has released an article stating that due to the massive U.S. fiscal deficit, there are concerns about the sustainability of debt, which puts pressure on long-term U.S. Treasury bonds and the dollar. However, there are signs that the U.S. stock market will continue to show resilience.

In the background of tariff hikes, Goldman Sachs' research department is cautious about the outlook for the U.S. economy: economists estimate that the average effective tariff rate will rise by around 14 percentage points in 2025, and another 3 percentage points next year, reaching nearly 20% by 2026.

How Will Tariffs Affect the U.S. Economy?

Goldman Sachs' chief economist Jan Hatzius expects that U.S. fourth-quarter GDP growth rate will be around 1%. The risk of economic recession is estimated to be around 30%, which is twice the historical average.

Hatzius said: "From an economic perspective, this will continue to be a difficult struggle. Economic growth will still be very slow." Although import tariffs have not had a significant impact on prices so far, Hatzius expects that the core inflation rate will rise by around 1 percentage point this year, reaching above 3%. Inflation increases will put pressure on consumer spending. Hatzius said: "Consumer spending has already been weak. It's come to a standstill, which is not often seen outside of recession."

How Will the U.S. Deficit Affect U.S. Debt and the Dollar?

Despite signs that investors have begun to accept higher tariffs, the deficit issue has become more pressing.

Goldman Sachs' vice chairman and former Dallas Federal Reserve Chairman Rob Kaplan said: "We've always been talking about the fiscal deficit problem, but from a net debt perspective, our leverage ratio is higher than at any time in our lives." He said that the U.S. current budget deficit is around $2 trillion, which is 6-7% of GDP, and is at a historical high outside of economic recession.

Kaplan said: "When the economy reaches or approaches full employment, we will start to reduce debt. And in economic recession times, the fiscal deficit will rise sharply."

Kaplan said that concerns about the fiscal deficit have already begun to affect longer-term U.S. government bond prices, with investors demanding higher yields for holding longer-term bonds, known as "term premium". Although U.S. long-term debt has historically been a global safe-haven asset, this year's long-term bond prices have not risen despite expectations of slower economic growth.

Kaplan said: "So the question is: Are 10-year and above government bonds still a safe-haven asset, or are they still an investment choice for investors? In the past few months, their performance has not been entirely consistent."

Hatzius said that he was previously more optimistic about U.S. fiscal prospects, such as after the 2008 financial crisis, when huge budget deficits accompanied rising unemployment rates. At the time, interest rates were much lower than actual GDP trend growth rate, which helped to offset the expansion of the deficit.

Hatzius said: "Many things have changed." The economy is no longer experiencing employment shortages, and actual interest rates are much higher. The yield on 10-year U.S. Treasury bonds with inflation protection is roughly equivalent to the potential growth rate of the U.S. economy. Hatzius said: "This means we can only tolerate a much smaller deficit." He pointed out that the deficit ratio needs to be lower by several percentage points to maintain stable debt-to-GDP growth.

Despite this, Goldman Sachs' global banking and markets co-head Ashok Varadhan said that U.S. government bond yields have already risen, making these securities attractive to private investors. This is different from the situation during the 2008 financial crisis or the COVID-19 pandemic, when real interest rates were negative after adjusting for inflation.

Varadhan said: "Now Treasuries are no longer expensive. Sovereign debt has reached a level that can attract private capital, and it still provides diversification." He expects that the U.S. government bond yield curve will become steeper: as the Federal Reserve lowers policy interest rates, short-term Treasury yields relative to long-term yields may fall.

Varadhan said: "The question is whether these data are enough to support a small or large relaxation of monetary policy." Many investors have become more pessimistic about the dollar due to fiscal concerns, and Goldman Sachs' research department expects the dollar to further depreciate. However, Varadhan said that the U.S. is not the only developed market with an unusually large budget deficit. He estimates that the U.S. budget deficit this year will be around 6% of GDP, France at 5.5%, and the UK at 3.6%. Varadhan believes that gold and cryptocurrencies such as Bitcoin may appreciate relative to fiat currency.

How Will the Stock Market Perform in a Deficit Expansion Background?

Kaplan said that while the increase in deficits may pose a challenge to long-term U.S. government bond yields, fiscal stimulus measures could still boost GDP growth rates in the short term. Fiscal stimulus measures combined with large investments in artificial intelligence, for example, may help explain why U.S. corporate earnings have been resilient.

Kaplan said that the ability to apply artificial intelligence will be crucial in the next few years. Many countries are facing aging populations, and many countries' debt-to-GDP ratios are higher than normal levels. This makes innovation and productivity enhancement especially important.

Varadhan said that although the U.S. stock market has already set a new high, he still "strongly recommends" it. Relaxing controls will bring assistance to the U.S. economy, and the U.S. must continue to fairly adjust trade relationships and attract the best, smartest, and most talented people into its labor force.

Varadhan said: "We're not even at the initial stage of corporate application (of artificial intelligence). Once companies start applying, they will be able to reap productivity benefits."