Brokerage Morgan Stanley on Monday warned that lofty U.S. equity valuations could be questioned by investors if aggressive fiscal spending is curtailed after the downgrade of sovereign debt by ratings agency Fitch last week.

MS equity strategist Michael J Wilson noted that massive fiscal stimulus, prompted by the COVID-19 pandemic since its outbreak in 2020, allowed the U.S. economy to grow faster than forecast.

This resilience in the face of rapid interest rate hike by the U.S. Federal Reserve has seen some Wall Street strategists chalking in a continued rally for some U.S. stocks.

The S&P 500 has already gained 17.2% so far this year, thanks to a handful of technology stocks that have ridden AI prospects high.

While aggressive fiscal spending could continue, given the debt ceiling has been raised, fiscal policy has limits as deficits would widen - one of the reasons for Fitch's downgrade.

As bonds - which fund the government's spending - sold off last week, there are bound to be repercussions. [US/]

"Investors will to call into question equity valuations, which were already high before the recent rise in yields," Wilson said in a weekend note.

"If fiscal spending must be curtailed due to higher political or funding costs, the unfinished earnings decline that began last year is more likely to resume."

(Reporting by Susan Mathew in Bengaluru; Editing by Shweta Agarwal)