How US Fiscal Law could impact the economy and Fixed-Income markets
7 JUL, 2025
Author: Blerina Uruçi, Chief US Economist, T. Rowe Price
Key takeaways
- The historic tax and spending legislation is attracting significant attention from financial markets due to concerns over its potential impact on the financial health of the US government.
- Passing this bill would reduce uncertainty about future fiscal policy and help stabilise an economy that has been shaken by numerous shocks this year. However, it also presents upside risks for inflation.
- Volatility in the US Treasury market is expected to continue due to fiscal concerns arising from the lack of plans to tackle the short-term deficit.
The historic tax and spending bill proposed by Donald Trump is sharpening financial markets’ focus on the country's challenging fiscal situation. This bill could pass as early as this summer; here, we explore the possible implications for the deficit, the economy, and bond markets.
Fiscal implications: The deficit will remain high
The tax and spending bill, referred to by President Trump as the "great beautiful bill," aims to extend many of the temporary corporate and individual tax cuts enacted during his first presidency in 2017. Since these expire at the end of this year, passing the bill would help avoid one of the largest nominal tax increases in US history. This alone should reduce uncertainty about the US business environment.
Unless major changes occur in the final legislation, the bill is expected to add more than $2 trillion to the deficit over the next decade, according to Congressional Budget Office estimates. Savings from reductions in federal spending, such as on healthcare, are unlikely to offset the revenue shortfall caused by the bill’s tax cuts. These cuts are expected to include increasing the cap on the State and Local Tax (SALT) deduction, enhanced child tax credits, and various corporate tax exemptions.
Since the bill's stimulus measures are expected to concentrate in the initial months, with spending cuts implemented later, any near-term improvement in the US government’s fiscal deficit seems unlikely. In 2024, the deficit reached 6.4% of gross domestic product (GDP), the largest in peacetime outside of a recession. Given the lack of plans to tackle the deficit, it is likely to remain elevated at current levels over the next two to three years.
Economic consequences: Favourable growth, upward inflation risks
The prospect of a new fiscal stimulus package should provide a timely boost to an economy that has slowed this year. Consumer spending and business confidence, in particular, could receive a much-needed boost. Although the bill will support economic activity, growth is expected to remain below trend this year due to the effects of tariffs. However, our baseline forecast is for a recession to be avoided.
Looking ahead to next year, economic growth should improve, as fiscal stimulus typically takes time to feed into the real economy. Businesses may react faster than consumers if capital expenditure tax reliefs are made retroactive to January 2025, aiming to maximise tax-relief benefits. However, it’s uncertain whether they can act quickly enough. Nevertheless, the improved growth rate is unlikely to offset the impact of reduced tax revenues on the fiscal deficit.
Regarding inflation, risks have shifted significantly upwards due to a combination of a weaker dollar, a historic rise in effective tariff rates, and the potential for rising energy prices stemming from the Israel-Iran conflict. A new fiscal stimulus package will likely add to these upward pressures but may take longer than other factors to filter into prices. Overall, the net effect is likely to be higher inflation in the second half of this year and through to 2026.
What does this mean for the Federal Reserve? The central bank’s latest projections showed at least two interest rate cutsthis year[1], but the window to implement these would be very short if inflationary pressures start to rise again and the labour market remains resilient.
Implications for fixed-income markets: Volatility in US Treasury markets will persist
Recent bond market movements indicate a shift in focus towards fiscal policy and away from tariffs. Given the absence of plans to tackle the deficit soon, volatility in US Treasury markets is likely to persist due to fiscal concerns. Ultimately, deficits must be financed through debt issuance. However, this occurs when other developed markets also need to issue more debt to finance deficits, creating competition for buyers. This, combined with increased inflation risks, is likely to push Treasury yields higher and steepen the US Treasury yield curve. However, this rise in yields is unlikely to occur in a straight line, and we are preparing for increased volatility in this uncertain market environment.
Overall, the "Great Beautiful Bill" appears likely to have significant economic, fiscal, and financial market implications. While the bill could support growth, it also poses upside risks for prices, coinciding with other inflationary factors such as tariffs. Alongside the lack of short-term plans to address the deficit, fiscal concerns will likely remain high, potentially driving yields higher and curves steeper.
