What happened?
Last month the Republican-controlled U.S House of Representatives narrowly passed a sweeping multi-trillion-dollar tax and spending bill likely to enact much of Trump’s policy agenda for his second term in the White House. As the bill now moves to the Senate, which will have the chance to approve or change some provisions of it, markets have delivered their initial verdict.
What are the details of the bill?
The package would cut both individual and corporate taxes deeply – essentially making permanent the sweeping income tax provisions of Trump’s 2017 Tax Cuts and Jobs Act, whilst also adding several temporary tax breaks to fulfil the president’s campaign promises.
The bill increases the deduction limit for state and local taxes (Salt), a significant issue for some in the Republican party. There is currently a $10,000 cap on how much taxpayers can deduct from the amount they owe in federal taxes, but under the new bill House Republicans have raised the Salt limit to $40,000 for married couples, with incomes up to $500,000.
In a move designed to make up for tax revenue loss, one of the more controversial details includes additional restrictions and requirements for Medicaid, the healthcare programme relied upon by millions of elderly, disabled and low-income Americans. However, the tax revenue loss would still swamp these spending reductions.
Of equal note during the campaign trail was Trump’s promise to end tax on tips and overtime pay, which were both successfully included. The bill would also boost military spending by $150 billion and add $175 billion for immigration enforcement. Other provisions include reorienting the government away from climate change provisions in favour of fossil fuels, and new language that would speed up the end of clean energy tax credits passed under the Biden administration.
Why are Bond markets concerned?
Following news at the start of last week that Moody’s had downgraded the country’s long-standing triple-A rating to Aa1 – blaming successive presidents for a ballooning budget deficit – concerns about fiscal sustainability were already growing, with government debt at uncomfortably high levels.
The non-partisan Committee for a Responsible Federal Budget estimates that the legislation would increase the public debt by at least $3.3tn through to the end of 2034. It would also increase the debt-to-GDP ratio from 100% today to a record 125%, the group said, which would exceed the rise to 117% projected over that period under current law.
With that, yields on the 30-year Treasury bonds passed the 5% mark on Wednesday, a signal that investors will require an additional premium to lend longer-term to the US government. This reflects concerns about not only a higher budget deficit, but potentially more elevated inflation too, which still remains short of the Federal Reserve’s 2% target – despite making good progress, more recently. This, combined with ongoing concerns around the impact of tariffs, will likely add to more immediate-term volatility.
How should investors respond?
Whilst these latest developments have added to an already uncertain environment, it is important to be mindful of the importance of a longer-term, strategic outlook. After President Trump’s ‘liberation day’ tariffs, in which the markets initially responded with a dramatic sell-off, the US large-cap index returned 19.6% from 8th April to 16th May, making it one of the sharpest comebacks in stock market history. We well know how markets can quickly gyrate over geo-political news, but we equally know that staying the course and sticking to one’s longer-term goals has proven to be the most appropriate course of action, and we do not expect any different this time around.
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