US equity markets continue reaching new highs, propelled by increasing confidence that “The One Big Beautiful Bill’ (OBBBA), signed into law on Independence Day will have positive economic results. The primary economic driver of the new law is preserving the tax cuts and small business deductions of 2017, thereby avoiding a return to the prior regressive tax rates that were a drag on the economy.
The new act also directs benefits to Millennials (born 1980 to 1996), Gen Z (born after 1996) and low to middle income families by providing tax relief on tips, overtime pay, auto loan interest deductions, increased child tax credits and a higher standard deduction. The estate tax exemption is now $15 million per person (designed to preserve small businesses and family farms) and there are new 529 education account incentives.
The risk Congress took in passing this bill is that expected higher GDP growth (from the ‘supply-side’ influences of lower taxes) will not offset the added spending in the act (including $150 billion for defense and border security). Overall government spending is estimated to be $7 trillion a year with annual inflows of about $5 trillion (ignoring hoped for additional revenue from GDP growth). This $2 trillion annual deficit, added to the current $30 trillion in debt (now about 100% of GDP), could rise over the next decade to about 130% of GDP, doubling interest payments on the debt (now about $1 trillion). Debt of that magnitude could imperil the US Dollar’s reserve currency status, leading to significant tax increases, or more money printing/ devaluation which is always inflationary, resulting in higher interest rates and ultimately, a slowing, recessionary economy.
The hope is that the supply side growth economic benefits of the new act can lower the budget deficit from roughly 7% of GDP to about 3% by realizing increased tax revenue from new growth. The problem is that historically, seeing all that new growth and lower budget deficit incentivizes politicians to increase spending again as occurred in the 1990’s following the fall of the Irom Curtain in 1989 (the so called ‘peace dividend’).
Also keep in mind that tariff market volatility could re-emerge on August 1, when the April 2nd ‘Liberation Day’ tariff pause ends. Although tariff confusion remains, preliminary deals have been reached with the UK, China and Vietnam and negotiations continue with the EU, India, Japan and Canada. The EU deals are likely to be most complicated, possibly leading to fragmentation and competing blocs of protective countermeasures on certain products. The good news is that to date, the US administration has not demonstrated an ideological belief in trade barriers and protectionism. Rather, it has leaned toward seeking ‘fair trade’, applying common sense and showing a willingness to compromise to avoid protectionism and chaotic securities markets.
The key question is whether tariffs can effectively achieve trade neutrality among trading nations through reciprocity or if trading partners will respond with retaliatory barriers that result in higher protectionist tariffs against American goods. This is a concern because approximately 40% of large American public company revenue comes from foreign markets.
As always, it is important to maintain a balanced, broadly diversified asset allocated investment plan. Don’t hesitate to call for further discussion.
