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US stocks declined on Wednesday as rising bond yields weighed on equities and investors digested both the ongoing US budget debate and renewed US-China tensions.

The S&P 500 fell 1.6% to 5,845, while the tech-heavy Nasdaq slid 1.4%. The pullback followed a weak 20-year Treasury auction, which helped push the 10-year yield up 10 basis points to 4.59% and the 30-year yield up 12 basis points to 5.08%, near its highest level since 2023. The US dollar index slipped to a two-week low of 99.6. S&P 500 futures on Thursday were up 0.2% at the time of writing.

Investor attention has focused on President Donald Trump’s sweeping tax and spending bill in Washington. An approval from the House Rules Committee overnight has set the stage for an imminent House vote on the “One Big, Beautiful Bill” before the market opens on Thursday. House Speaker Mike Johnson expressed confidence that the bill would pass the House. Concerns about the US deficit and rising debt levels have contributed to the recent rise in bond yields.

The move in yields also followed a decline in Japanese government bond yields this week and a higher-than-expected UK CPI print. Adding to the upward pressure, the Atlanta Fed’s latest GDPNow estimate signaled stronger-than-expected US growth. As a result, fed fund futures are now pricing in just 48 basis points of rate cuts for the rest of the year, lower than previously anticipated.

Elsewhere, sentiment has weakened as US-China relations over AI chips have come back into focus, just days after a temporary truce on tariffs. Since that deal was announced, the US has issued an industry warning against the use of Chinese chips, singling out Huawei. In response, China accused the US of undermining the preliminary trade deal, demanded that the Trump administration “correct its mistakes,” and called the guidance discriminatory and market-distorting, while warning of “resolute measures” if US actions continue to harm China’s interests.

What do we think?
Further progress appears necessary for any lasting trade agreement. While the temporary pause in tariffs sparked a relief rally, the outlook for a more permanent deal remains uncertain. Exchanges of rhetoric between Washington and Beijing have cast doubt on the durability of the agreement. Treasury Secretary Scott Bessent said in television interviews over the weekend that the paused “reciprocal" tariffs could be reimposed on trading partners that do not negotiate in “good faith.” In addition, industries such as semiconductors, pharmaceuticals, and lumber could still face potential sectoral tariffs. Our base case is that the US effective tariff rate will eventually settle around 15%, still well above the 2.5% rate seen prior to President Trump’s return to office.

Trump’s tax cuts could add pressure to the bond market. Treasury yields have climbed steadily since the end of April as budget negotiations have come to the fore. Trump’s tax cut package is likely to see various amendments before it is signed into law, but it nonetheless is expected to add trillions of dollars to the country’s USD 36tr deficit over the next decade. This will likely lead to an increase in the supply of Treasury debt, exerting pressure on the bond market.

The Federal Reserve is in no hurry to cut rates. We believe the US economy will avoid a recession this year, and the Fed is taking a “patient” approach in cutting interest rates as policymakers monitor the inflationary effect of Trump’s tariffs. Earlier this week, New York Fed President John Williams said the US central bank may not be ready to lower rates before September, while Atlanta Fed Chief Raphael Bostic signaled an unwillingness to move rates for some time. We forecast GDP growth to slow to about 1.5% in 2025, and we expect 100 basis points of Fed rate cuts starting in September.

How do we invest?
Market volatility has resurfaced amid renewed uncertainty surrounding trade policy and the fiscal outlook. With bond yields elevated and tariff and budget risks in focus, this volatility may persist as investors monitor further developments in policy.

Against this backdrop, our recommendations include:

Seek durable income. While there is a risk that bond yields could rise further in the weeks ahead in anticipation of higher US fiscal deficits, we believe current (or higher) yield levels offer an opportunity for investors to lock in durable portfolio income. Our preference remains for medium-tenor USD bonds of around five years, but depending on the market reaction in longer-term yields, additional investment opportunities may emerge in the days ahead. We expect Treasury yields to fall into year-end and believe high-quality government and investment grade bonds remain attractive for diversification and income.

Phase into equities. We recently cut our Attractive rating on US equities to Neutral, following the strong recent rally. However, our current Neutral rating on US equities should not be mistaken for a bearish view, and we continue to recommend a full strategic allocation. The recent earnings season has demonstrated the strength in structural AI earnings trends. We expect US stocks to move higher over the next 12 months, and we maintain our sector-level Attractive ratings on US communications services, information technology, health care, and utilities. We also maintain strong conviction in the long-term potential of our Transformational Innovation Opportunity themes of Artificial intelligence, Power and resources, and Longevity.