Goldman Sachs: How are current economic data priced in the US stock market? How does fiscal risk affect the US dollar?

Goldman Sachs believes that the US May non-farm payroll data continues to show resilience, with the stock market pricing in an optimistic growth outlook. The market is pricing in both upward and downward risks for economic growth. Significant deterioration in economic data could challenge investors' ability to overlook recent weakness. On the contrary, there is still room for further improvement in soft data, which will support the stock market to continue moving upwards. As for the US dollar, concerns about fiscal sustainability in the US and reduced demand from foreign investors for US assets may make fiscal expansion more costly through higher yields and a weaker dollar. Goldman Sachs' global stock systematic macro strategy holdings data show that the strategy saw a slight increase in positions last week, with holdings close to the historical median (around 5 out of 10) and an expected increase of approximately $20 billion in the next month in the base scenario (with nearly half flowing into the US market). I. How is the market pricing in economic data? Goldman Sachs' report indicates that last week's strong employment report highlighted the continued resilience of hard economic data. In May, non-farm payrolls increased by 139,000, and the unemployment rate remained at 4.2%. However, despite the strong hard data so far, it is expected that data will soften in the coming months. Internal rotation in the stock market indicates that investors are pricing in an optimistic growth outlook. The performance of cyclical stocks and defensive stocks reflects expectations of approximately 2% real GDP growth in the US. Goldman Sachs economists expect real GDP growth to be around 1% in the next four quarters. Many clients are concerned about the risks of a rebound in the market and pricing in growth before the data weakens for three reasons: First, soft economic data tends to stabilize before hard data hits bottom. The correlation between the S&P 500 index return and soft data is currently higher than that with hard data. If the recovery in soft data continues, it should support stock market returns even if hard data weakens. Second, investors may be overlooking recent weakness while looking ahead to 2026. Goldman Sachs economists predict that the annualized quarter-on-quarter real GDP growth in the US will slow to 0.4% in the fourth quarter of 2025, but rebound to 2.0% by the fourth quarter of 2026. Third, the growth expectations in Goldman's industry-neutral economic sensitive stock basket are slightly lower than those in the combination of cyclical and defensive stocks. The median valuation of high operating leverage stocks (GSTHOPHI) is close to historical maximum discount compared to low operating leverage stocks (GSTHOPLO). Goldman Sachs believes that there are both upward and downward risks in the market's pricing of economic growth. Significant deterioration in economic data could challenge investors' ability to overlook recent weakness. On the contrary, there is still room for further improvement in soft data, which will support the stock market to continue moving upwards. Chart 1: Pricing of economic growth by cyclical stocks and defensive stocks (Left axis: Index return of cyclical and defensive stocks; Right axis: Market consensus expectations and Goldman's forecasts for the future four-quarter US GDP growth rates) Chart 2: The S&P 500 index usually bottoms out before hard data (Left axis: Changes in hard and soft data; Right axis: S&P 500 index performance normalized, with key catalyst events as the base date) Chart 3: The S&P 500 index rebounds with soft data while hard data remains stable (Left axis: Changes in hard and soft data year-to-date; Right axis: S&P 500 index points) Chart 4: Correlation between S&P 500 index returns and hard/soft data (Based on monthly CAI data and 12-month rolling correlation of S&P 500 index monthly returns) II. How does fiscal risk affect the US dollar? Goldman Sachs' global foreign exchange trader Kamakshya Trivedi states that entering the summer, the US dollar index has fallen by about 6% year-to-date, completely reversing its gains from April 2024. Meanwhile, over the past six weeks, the US dollar has remained relatively stable against other major developed market currencies. Consequently, investors now see more two-way risks around the currency than at any time before, which is not surprising. However, despite this rapid and meaningful adjustment - typical behavior near currency peaks - Goldman still believes that this is more of the "beginning of the end" for the dollar's turnaround, rather than the "end of the beginning". Goldman has adjusted its forecasts for the Euro/US Dollar to 1.17, 1.20, and 1.25 in 3 months, 6 months, and 12 months, respectively (previously 1.10, 1.15, and 1.20). Fiscal sustainability has become a focal point of concern for investors, not only in the US but also in the UK and Japan. The timing of budget processes has shifted the focus of the market onto the sustained demand for US assets from foreign investors, amidst concerns about fiscal deficits in the US. The impact of fiscal expansion on the US dollar is mixed at best, typically depending on the economic cycle and monetary policy status. However, on average, an increase in net issuance of US Treasury securities tends to benefit the US dollar. This is partially due to structural demand for US Treasury bonds from foreign countries - foreign capital inflows usually increase along with the net issuance of US Treasury securities, a competitive advantage the US has over its G10 peers. Nevertheless, due to the weakening of US exceptionalism and fiscal risks, the willingness of foreign investors to absorb US assets may change the way the US dollar reacts to fiscal expansion. Locally, Goldman found differences in how the market prices US fiscal risks among different currency pairs. Sharp expansions in the yield spread between US 5-year and 30-year Treasury bonds often put greater pressure on high-yield currencies such as the Brazilian Real, Mexican Peso, and Indian Rupee, although recent evidence suggests that emerging market local rates have strengthened resistance to rising US Treasury yields. At the same time, sharp increases in the US credit default swap (CDS) spreads are often associated with weaker performance of more cyclical currencies such as the South African Rand, Norwegian Krone, and Australian Dollar. Although investors have accepted higher yields as sufficient compensation for holding US Treasury securities in recent years, concerns about fiscal sustainability and reduced demand for US assets from foreign investors may lead to a shift in how the US dollar responds to fiscal expansion.It can make fiscal expansion more cost-effective through dual channels of higher yields and a weaker US dollar.Charts 1: Concerns about fiscal sustainability have led to a brief but sharp divergence between the US dollar and interest rates, but this relationship has returned to normal in recent days. (4-week rolling beta coefficient of G10 currency pairs against the US dollar and the difference in 5-year real interest rates on US Treasuries) Charts 2: Historically, an increase in US Treasury net issuance has been beneficial for the US dollar, but has had a smaller impact on other G4 economies. (Estimated percentage impact of a 1% of GDP increase in US Treasury net issuance on exchange rate returns) Charts 3: Foreign demand for US Treasuries typically increases with an increase in net issuance. (Comparison of US Treasury net issuance and foreign capital inflows; net issuance of government bonds in the eurozone, UK, and Japan and foreign capital inflows)