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A quiet week in 2025 is a pipedream. The calm that followed the 90-day trade truce with China has quickly evaporated, as markets shift their attention to the next priority of the US administration: tax cuts.
The latest twist in the US saga began last Friday, when Moody’s moved to strip the US of its Aaa credit rating. The decision by itself should not come as a surprise to anyone. Standard and Poor’s downgraded the US back in the Obama administration in August 2011, while Fitch cut the rating in the Biden administration in August 2023.
Although Moody’s was clearly late to the party on concerns around US fiscal sustainability, the decision highlights that the fiscal policies under consideration by the current administration will not address the building budget deficits and debt within the US economy. Rather, the opposite is the case, with Moody’s noting that the “fiscal performance is likely to deteriorate”.
The outlook for US fiscal policy became clearer this week following passage by the House of the "One Big Beautiful Bill". Preliminary estimates put the cost of the Bill at around US$2.4 trillion over the next decade and, including interest, we estimate the total cost would be around US$3 trillion.
However, the House approved the Bill without knowing the exact cost after rival Republican factions required last minute amendments in order to secure their votes.
The centrepiece of the bill is an extension of Trump’s 2017 tax cuts that were due to expire at the end of the year. Extending these measures were never in doubt and are estimated to have cost the budget around US$3.9 trillion before interest. The bill also contained another US$950 billion of new individual tax cuts. This included no tax on tips, no tax on overtime, no tax on car loans, higher deductions for seniors and more generous deductions for state and local tax payments. The bill also included around US$270 billion of new business tax breaks, largely by providing a special depreciation allowance for new factories. We also saw an additional US$200 billion for additional spending on armed services and homeland security to support President Trump’s defence and immigration agenda. However, of note, the bill does not include a cut in the corporate tax rate as campaigned by President Trump.
Offsetting this $5.1 trillion of fiscal expansion, Republicans agreed on $2.7 trillion of cutbacks. The savings centred on phasing out Biden’s clean energy and IRA programs, cuts to Medicaid and other health programs, cuts to food stamps and cuts to student loans.
The bill was also designed so that more of the tax cuts were front-loaded, while more of the spending cuts were back loaded. Many of the new tax cuts also contained sunset clauses, such that they expire at the end of 2028. In other words, the bill is stimulatory to the economy in the next three years before weighing on growth in the next decade. We estimate that the bill would increase the budget deficit by 1.5ppts in FY2026 compared to a current law baseline (where the existing tax cuts expire as legislated) or 0.9ppts under a current policy baseline (where the existing tax cuts are assumed to continue). Given it takes time for the additional tax cuts to flow through to economic activity, we estimate the bill will provide a boost to US real GDP growth of around ½ ppt over 2026.
In our view, the risks around this economic impulse are balanced. On the upside, the business investment incentives could encourage more onshoring in a post Liberation Day world, leading to larger multipliers than embedded within our model. On the downside, there is a risk that this bill could be a catalyst for a reassessment of the term premium by the bond market, leading to tighter financial conditions across the economy.
Bond markets have certainly moved to price in a higher term premium this week, with a well-known measure produced by the NY Federal Reserve up 20bps in the space of a few days and the US 10-year government bond yield rising back above 4.50%. The deteriorating fiscal outlook, with the budget deficit heading towards 7% of GDP and federal government debt on a trajectory to rise from 100% of GDP to close to 125% of GDP by 2034, finally appears to be coming home to roost for the US government.
Shenanigans by the Senate Budget Committee Chair to assess the bill under a current policy baseline (vs a current law baseline as has always been the case in reconciliation bills) has only compounded concerns of weakening fiscal discipline by the US government. This sleight of hand makes it more likely that temporary tax cuts can become permanent, meaning the true cost of this bill is close to US$5 trillion over the next decade. Although this fiscal bill may still be amended by the Senate, the US administration remains a long way from addressing the structural budget problems plaguing the economy. Problems that tariff revenue alone will not fix.
