Is there a significant adjustment risk in the US stock market: Trump's tax cut plan, fiscal year 2026 budget, sovereign credit rating downgrade

Amid multiple pressures in the financial market, Moody's suddenly announced a downgrade of the U.S. sovereign credit rating, lowering it from Aaa to Aa1, causing the U.S. to completely lose the highest rating from the three major rating agencies. This move coincides closely with the sprint phase of Trump's tax cut plan and the deadlock in the government budget.

On May 18, the team of Liu Chenming and Zheng Kai from GF Securities released a latest report analyzing whether the Trump tax cut plan, the fiscal budget for FY 2026, and the downgrade of the sovereign credit rating would pose significant adjustment risks to the U.S. stock market.

The report pointed out that the outlook for the Trump tax cut plan remains uncertain; based on the budget outline, the U.S. FY 2026 budget may not have truly entered a "tightening moment"; the downgrade of the U.S. sovereign credit rating has little mid-term impact on the U.S. stock market.

Outlook for the Trump Tax Cut Plan Uncertain

In terms of the fiscal budget, GF Securities noted that currently, the U.S. FY 2025 fiscal budget has not yet been finalized, and Congress continues to rely on continuing resolutions to operate until the end of September, remaining in a state of fiscal abnormality.

The Senate and House passed the budget resolution for FY 2025 in February 2025, and amendments were passed in April, mainly paving the way for the Trump tax cut plan. Among them, the House set a goal of $4.5 trillion in tax cuts, $2 trillion in spending cuts over ten years, and a $4 trillion increase in the debt ceiling; the Senate set a goal of $5.3 trillion in tax cuts, $1.2 trillion in spending cuts over ten years, and a $5 trillion increase in the debt ceiling.

On May 12, the U.S. House Ways and Means Committee announced the Trump tax proposal "The One Big Beautiful Bill," which plans to cut taxes by over $4 trillion over the next decade and reduce spending by at least $1.5 trillion, making the 2017 Trump tax cuts permanent.

Currently, the Republican Party has set the following timeline for advancement:

(1) By the end of May 2025: The House completes the review and passes the bill;

(2) Before July 4, 2025 (Independence Day): Complete the Senate review and submit it for presidential signature.

This bill makes the 2017 Trump tax cuts permanent (if not passed, the average tax burden on ordinary taxpayers will increase by 22%) and also includes expanding the child tax credit and providing temporary tax cuts for tips and overtime pay. The U.S. government claims that the tax cut plan will result in:

(1) Real wages increasing by $3,300 per year;

(2) Real wages for middle-income families increasing by $5,000 per year;

(3) Short-term real GDP growing by 3.3-3.8%, and long-term real GDP growing by 2.6-3.2%; (4) 4.1 million jobs will be preserved.

Fiscal Year 2026 Budget: May Not Have Truly Entered "Tightening Moment"

The report points out that the Republicans set a tight schedule for advancement on May 2, when the White House released the outline of the Fiscal Year 2026 budget proposal (mainly concerning discretionary spending). Among them, defense discretionary spending remains unchanged, while non-defense discretionary spending decreases by more than $160 billion (a drop of 23%) compared to 2025, to over $550 billion. Departments with significant cuts include: National Science Foundation, Environment, Housing, Health, etc. More detailed proposals may be announced in the coming weeks.

Although the proportion of non-defense discretionary spending in the U.S. Fiscal Year 2026 budget has decreased by 23%, historically, there is no clear relationship between the proportion of non-defense discretionary spending and overall economic growth, as its share has continued to decline for nearly 20 years.

Moody's Downgrades U.S. Rating: Market Volatility May Be Far Less Than in 2011

On May 16, Moody's downgraded the U.S. sovereign credit rating from Aaa to Aa1. As a result, the U.S. has lost the highest rating from the three major rating agencies. However, unlike the panic in the market caused by S&P's downgrade of the U.S. rating in 2011, the impact of this rating adjustment on the market may be limited.

According to Wall Street veteran strategist Jim Bianco, the root of the market panic in 2011 was that U.S. Treasury bonds might no longer meet the criteria for eligible collateral, forcing institutions to sell off. After 2011, relevant contracts have been rewritten, changing the requirement to "government securities," eliminating specific credit rating qualifications.

Guotai Junan Securities believes that, based on historical experience, short-term rating adjustments may lead to rising bond yields and stock market volatility, but the mid-term impact is relatively limited.

If the fundamentals remain resilient, the market is expected to return to an upward trajectory. Current U.S. economic data still shows strong resilience, whether in high-frequency consumption data or durable goods orders, with no obvious signs of recession.

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