Spending cuts and mass layoffs have made growth the biggest question mark for US stocks

• Investors are questioning the US growth prospects as big cuts to federal spending and employment loom.
• A stock decline sparked by weak economic data last week gave investors a taste of what a growth slowdown could look like.
• Federal spending cuts and immigration policy changes are adding to the economic uncertainty.

Investors are starting to question the growth prospects of the US economy as thousands of federal employees are targeted for layoffs amid a broad push to cut government spending.

While the S&P 500 is only 2% below its record high, a broad sell-off on Friday sparked by weak economic data damaged high-flying stocks, including retail favorites like Palantir and Walmart.

Weaker-than-expected S&P Global Purchasing Managers Index data pointed to slowing economic growth, with Sam Tombs, chief US economist at Pantheon Macro, estimating that US GDP is headed to 2% this quarter, down from 3.2% in the fourth quarter of 2024.

“Businesses cited uncertainty over the severity of federal spending cuts and tariffs as the main reason why they are delaying expenditure,” Tombs said of the PMI survey in a note on Monday.

Uncertainty surrounding federal spending cuts is being exacerbated by DOGE’s crusade to cull the federal workforce.

According to Torsten Sløk, chief economist at Apollo, the Elon Musk-led DOGE job cuts could eliminate as many as 300,000 federal positions.

While that would be a small number relative to the 160 million total employed people, it could have broad knock-on effects.

“Studies show that for every federal employee, there are two contractors. As a result, layoffs could potentially be closer to 1 million,” Sløk, chief economist at Apollo, said in a note over the weekend.

Sløk is watching weekly initial jobless claims data to gauge when the layoffs might start negatively affecting the economy. Initial jobless claims in Washington, DC, are starting to rise, Sløk said.

“Any increase in layoffs will push jobless claims higher over the coming weeks, and such a rise in the unemployment rate is likely to have consequences for rates, equities, and credit,” Sløk said.

Morgan Stanley, meanwhile, noted that it’s not just DOGE that is shaking up the US growth debate among investors.

Uncertainty around the government’s immigration policy is a growth headwind and is also likely to create upside pressure on inflation.

“The immediate policy changes from the new administration (immigration enforcement and tariffs) are likely to weigh on growth while providing little relief on inflation,” Morgan Stanley CIO and chief equity strategist. Mike Wilson, wrote.

Wilson added that factors fueling the growth debate are also why the S&P 500 has been having trouble pushing past the “formidable resistance” level of 6,100 in recent weeks.

As to how much the policy uncertainty could weigh on growth, the Federal Reserve of Atlanta estimates first quarter GDP growth of 2.3%, down from a high of 3.9% in early February.