As voting on Donald Trump’s tax and spending bill continues in the US House, Blerina Uruci, chief US economist at T. Rowe Price, explores the potential implications for the American deficit, economy, and bond markets.
The tax and spending bill, which President Trump refers to as the ‘big beautiful bill’, aims to extend many of the non-permanent corporate and individual tax cuts enacted during his first presidency in 2017. As these are due to expire at the end of this year, the bill’s passage would help avoid one of the largest nominal tax hikes in US history. This, in itself, should reduce uncertainty about the business climate in the US to some extent.
The bill is expected to add more than $2trn to the deficit over the next decade, according to Congressional Budget Office estimates. This is because the savings from reductions in federal spending, such as on healthcare, are unlikely to offset the fall in revenue resulting from the bill’s tax cuts.
With the bill’s stimulus expected to be frontloaded and the spending cuts coming later, any near-term improvement in the US government’s fiscal deficit seems unlikely. In 2024, the deficit stood at 6.4% GDP, which was the largest ever in peacetime and outside of a recession. Given the lack of plans to address the deficit, it is likely to remain elevated at current levels over the next two to three years.
US to avoid a recession
The prospect of a new fiscal stimulus package should provide a timely boost to an economy that has been slowing this year. Consumer spending and business confidence, in particular, could receive a much-needed lift. While the bill will be supportive of economic activity, growth is still expected to be below-trend this year due to the effects of tariffs. However, in our baseline forecast a recession will be avoided.
Looking ahead to next year, economic growth should improve as fiscal stimulus typically takes time to feed through into the real economy. Firms may react more quickly than consumers if tax breaks on capital expenditure spending are made retroactive to January 2025, as they would aim to maximise the benefits of the tax break. However, there is uncertainty on whether they would be able to move fast enough. Nonetheless, the improvement in the growth rate is unlikely to offset the effect of lower tax revenues on the fiscal deficit.
Regarding inflation, risks to the outlook have shifted significantly to the upside based on a combination of dollar weakness, a historic rise in the effective tariff rate, and the possibility of higher energy prices. A new fiscal stimulus package would likely add to these upside pressures but may take more time than some of the other factors to filter through into prices. Overall, the net effect is likely to be higher inflation in the second half of this year and into 2026.
What could this mean for the Federal Reserve? The central bank’s latest projections showed at least two interest rate cuts for this year, but the window to deliver these would be very short if inflation pressures start to pick up.
Continued treasury turbulence
Recent bond market moves indicate a shift in focus toward fiscal policy and away from tariffs. Given the absence of plans to address the deficit in the near future, volatility in treasury markets due to fiscal concerns is likely to persist.
Ultimately, deficits need to be financed through debt issuance, but this comes at a time when other developed markets also need to issue more debt to finance deficits, creating competition for buyers. This, together with rising inflation risks, is likely to drive treasury yields higher and the US treasury yield curve steeper. However, the move higher in yields is unlikely to happen in a straight line, and we are bracing for more volatility in this highly uncertain market environment.
Overall, the ‘big beautiful bill’ looks set to have meaningful economic, fiscal, and financial market implications. While the bill could support growth, it also poses an upside risk to prices, coinciding with several other factors, such as tariffs, that could drive inflation higher. Combined with the lack of near-term plans to address the deficit, fiscal concerns are likely to remain elevated, potentially driving yields higher and curves steeper.
