‘Big Beautiful Bill’ brings fiscal concerns

Fiscal fears and rising bond yields dominated the market narrative last week. For some, perhaps, it was a break from worrying about trade and tariffs — but that break was brief. On Friday, President Trump threatened a 50% tariff on the European Union (EU) starting in June¹ and a 25% levy on Apple.²

We’re not in the camp that thinks a US default is a meaningful probability (noted in our article last week), but we do think fiscal concerns could manifest in higher US bond yields and higher term premia. Non-US government bonds and shorter-duration bonds appear attractive to us today.

‘Big Beautiful Bill’ brings fiscal worries

Trump’s Big Beautiful Bill — a wide-ranging legislative package that includes tax breaks, spending cuts, and much more — narrowly passed the US House of Representatives on Thursday by a 215-214 vote. It now goes to the Senate. Even though the Republicans have a larger margin in the Senate (53-47) compared to the House, passage might not be smooth, and changes to the bill are expected.

Some of the fiscal hawks in the Senate aren’t happy with the idea of raising the debt ceiling by some $4 trillion,³ which is included in the bill. Including the debt ceiling puts an effective deadline on passing the bill around late July or early August. That’s when the US Treasury is projected to run out of money, according to the Congressional Budget Office.⁴

The bill extends the Trump 1.0 tax cuts, due to expire at the end of 2025, and pushes any cuts until after the next election. Moody’s estimates that the deficit will rise from 6.4% to about 9% of gross domestic product by 2035.⁵  These tax changes have raised fiscal fears in the market and have been a key driver for higher long-term yields in recent weeks, in our view.

US bond yields: Higher is the path of least resistance

The US Treasury auctioned 20-year bonds on Wednesday with a 5% coupon rate that was the highest since the tenor was reintroduced in 2020.⁶ It wasn’t quite as strong as the market would have liked, in our view, and long-end yields moved higher.⁷ Some investors may have preferred short-term US Treasuries or foreign bonds, given the lack of additional yield from longer-dated US Treasuries or the potential for foreign currency to appreciate versus the US dollar. We would be wary of reading too much into this auction. The 20-year typically doesn’t have the strongest demand at the best of times.

Still, the fact that yields moved higher last week⁸ and the US dollar lower⁹ may tell us that the normal link between yields and currencies is no longer there. Fiscal and growth concerns have been driving the dollar lower, and we think that trend will persist. US Treasury yields are more likely to move higher than lower while fiscal concerns remain, in our view.

President Trump is calling for the Federal Reserve (Fed) to cut rates. We don’t agree and think that if the Fed succumbs to pressure from the president while the hard data are still resilient, then US bond yields could rise, not fall.

Tariffs: Threats are back

After a few weeks of respite from tariff escalation, there isn’t too much we can say about Trump’s threat to raise tariffs on the EU and Apple, except that market participants should probably get used to this constant waxing and waning in tariff news. Markets might naturally swing around with the news flow. Our takeaway from reading Trump’s Art of the Deal is that this is part of his process to throw parties off balance. After the initial aggressive asks and then the step back, it appears we’re in a period of upping the ante again.

US labor market: Data should keep Fed on hold

The Flash Composite Purchasing Managers’ Index printed 52.1 for May, compared to 50.6 in April.¹⁰ US initial jobless claims ticked marginally higher last week but remain low by historical standards.¹¹ Broadly, US labor market data still suggests that the US economy isn’t headed for an imminent recession. While this remains the case, we see little reason for the Fed to cut rates further.

UK inflation: Higher than expected

UK headline Consumer Price Inflation (CPI) for April came in at 3.5%, significantly higher than the March figure of 2.6% and above Bloomberg consensus forecasts.¹² A higher inflation reading was widely expected as April saw utility, mobile phone, road tax, and TV license prices rise. That wasn’t a surprise. At face value, however, airfares rising by 16.2% compared to last year was of greater importance and meant services inflation rose by 5.4%.¹² The Bank of England (BOE) watches services inflation closely, and this higher rate calls into question the speed of the cutting cycle. Market pricing suggests the BOE may now cut between one and two times this year. We think the weakness in the labor market and softer inflation in the coming months mean the BOE is more likely to cut rates more quickly. The pound rallied on the news.¹³

EU-UK deal: Step in right direction

Last week’s EU-UK summit concluded with a series of agreements and statements pointing to closer alignment in Europe. The agreements pave the way for greater coordination and cooperation on defense procurement and migration. Also, the agreement to align on sanitary and phytosanitary, controlling plant disease areas, covering the UK and EU may make it easier for agricultural products to be traded across the region once more. In response, EU fishermen have access to UK waters for another 12 years. These agreements aren’t game-changing in and of themselves, but they could indicate improvement in the direction of EU–UK relations over the coming years. At the margin, this news is positive for the British pound and euro.

So what? Potential market and central bank response

Overall, it was another busy news week, but nothing that shifted us away from our core big picture views. We expect the US dollar to weaken further, the rest of the world’s stocks to outperform, and many investors to be wary of holding longer-dated US Treasuries.

We’re debating how the Fed will react to this highly uncertain macro backdrop, but on balance, we think cuts will only start when there’s a meaningful weakening in labor market data. We’re not there yet, in our view. The BOE, though, despite higher inflation prints last week, is likely to cut more quickly than current market pricing, in our opinion.