This week’s blog is written by portfolio manager CJ Cowan.
On Thursday 22 May, the House of Representatives passed what Trump has dubbed his ‘Big Beautiful Bill’ by just one vote.
This bill is designed to deliver on many of Trump's campaign promises, such as extending the 2017 corporate and individual tax cuts and eliminating tax on both tips and overtime. These tax cuts will be partly offset by reductions in spending on Medicaid and food aid programs. The bill will now progress to the Senate.
The Republicans are using the budget reconciliation process to pass this bill. This means that when it goes to the Senate, there is a 20-hour time limit for debate, and it can be passed with a simple majority, thus removing the Democrats' ability to filibuster. As the Republicans control both the House and the Senate, albeit narrowly, this keeps the ball in their court regarding the finer details of the bill.
The extension of prior tax cuts doesn’t provide a stimulus for growth or worsen the annual budget deficit. Growth is about change and to elicit a change in the growth rate you would need to see a change in the tax rate. The change in tax rates occurred in 2017, so the positive impact on growth has already been experienced. Not extending these tax breaks that are due to expire would be a negative impulse for economic growth but extending them won't push the US growth rate higher on its own.
Cutting tax on tips and overtime could affect tax receipts, contracted hours worked, and inflation rates. Of course, the first impact is that tax receipts from them fall to zero. Differing tax treatment might also encourage more hours to be billed as overtime rather than as regular contracted hours, negatively impacting income tax receipts further. Additionally, it could lead to a reduction in hourly pay but more tipping., This could put downward pressure on officially measured inflation rates but not on real world costs for consumers.
While Trump may describe the bill as big and beautiful, this bill will likely only have a small positive effect on the economic growth trajectory of the US. The Congressional Budget Office (CBO) estimates that the bill would add US$2.3tn to deficits over the next decade. This is at the low end of estimates from other independent organisations, such as the Committee for a Responsible Federal Budget, which sees a US$3.1tn addition to public debt, which currently stands at US$36tn.
This comes at an awkward moment, as Moody’s recently became the final one of the big three credit rating agencies to downgrade the US from its top-tier Aaa status. The downgrade is almost inconsequential for the US government and doesn’t reveal anything new. It has been a topic of discussion that the US is on an unsustainable fiscal path with wide annual budget deficits and an increasing debt to GDP ratio, which is now over 120%. Moody’s downgrade suggests no realistic prospect of improvement soon, and the details of the Big Beautiful Bill support that view.
Bond markets have not reacted favourably, with the yield on 30-year Treasuries rising above 5%. We expect investors will continue to demand higher yields for lending to the US government for longer terms, maintaining the steepening pressure on the yield curve. However, despite some turbulence over the past month, US Treasuries remain the number one global ‘safe asset’, so a run on them in the style of the UK gilt crisis of 2022 still feels like it is only a remote possibility.
The picture for US equities is murkier. Fiscal deficits are typically great for the stock market as they lead to a transfer from the US government to corporate earnings. So, as long as the US government overspends, we should expect the stock market to rise. The downside is that worsening creditworthiness should lead to a weaker US dollar, so international investors might lose from currency exposure what they gain from US equities.
CJ is a portfolio manager of the Quilter Investors Cirilium and Monthly Income Portfolios. CJ joined Quilter Investors in August 2018 from Aberdeen Standard Investments where he worked in the global macro team, managing global government bond and global aggregate portfolios.
CJ is a CFA charterholder and has also completed the Chartered Alternative Investment Analyst qualification. CJ has a degree in economics from the University of Bristol and an MPHil in Economic and Social History from Brasenose College, University of Oxford.
Effective protection strategies in uncertain times
Equity market participants seem to have consigned April’s tariff induced sell-off to the rear-view mirror – over the past few weeks, markets have rebounded strongly amid more benign news flow, resilient macroeconomic data, and solid company earnings.
