Tim Graf (TG): This is Street Signals, a weekly conversation about markets and macro brought to you by State Street Markets. I'm your host, Tim Graf, head of Macro Strategy for Europe. Each week we talk about the latest insights from our award winning research as well as the current thinking from our strategists, traders, business leaders, clients and other experts from financial markets. If you listen to us and like what you're hearing, please subscribe, Leave us a good review, get in touch. It all helps us to improve what we offer. With that, here's what's on our minds this week.
We are back for a couple of episodes before I go on a proper holiday for the summer. And we're going to spend the next couple of episodes focusing on the US Political economy in both the short run and the long run. This week we're going to focus on the here and now. July 4th weekend brought with it the passage of President Trump's One Big Beautiful Bill of tax cuts and the alterations to entitlements that are meant to help fund it. Close on its heels came the return of tariff related headlines. We are at now the end of the three-month deferral period for many of the tariffs. Originally announced in early April on Liberation Day. Those measures created significant uncertainty for markets at the time and the worry is that with risk markets all the way back at their highs, volatility could return. So here to talk through it all is one of our best voices on politics and the link between politics and the markets, Noel Dixon, a macro strategist from our team in Boston. Hey, Noel.
Noel Dixon (ND): Hey. What's going on?
TG: Oh, oh, it's all going on. It's a bit hectic these days. I want to start with fiscal policy and the passage of the Big Beautiful Bill, the one Big Beautiful Bill that is there. There's not going to be another. Let's, let's assume that. I was reading a piece yesterday from the Free Press and the assessment they got people from all sorts of the know, all sides of the political spectrum and the assessment was really positive or negative, depending on where you stood along that political spectrum. So I'm going to put the challenge to you as an ostensibly independent person, particularly on the question of what this means for stimulus to the US economy, which you have a growth rate that is slowing. We are not anywhere close to recession yet, but we do see slowing growth.
How stimulative is this bill in the short and the medium term to maybe mitigate some of those recessionary risks?
ND: My take is that I do think it is stimulative and you're right, it is a big debate. But I do think it's very stimulative, particularly on the corporate side. So, a lot of the key provisions are retroactive. I think that's the first point to make. For example, the 100 percent bonus depreciation on property, plant and equipment that goes back to 100 percent starting January 19th of this year. It was set to phase down to 40 percent for this year and it was currently at 60 percent from 2024. So, businesses will naturally take advantage of that. If you had what they call QPP, qualified production property, where anything you produce or grow in the US, any software equipment that should help, obviously the tech companies, any sound recordings, things like that, et cetera, you also get another 100 percent expensing there. If you look at R and D that is deductible, it still has to be amortized over 15 years. But not only is it retroactive for 2025, but corporations could, anything they capitalized domestically for R and D, they could account for that. They could do a catch up on that from 2022to 2024. And small businesses, eligible small businesses can actually go as far back as 2021. So, that for sure is very stimulative. And then I would finish off with ancillary benefits for consumers. So no taxes on tips over time for individuals making US$150,000 or less or married couples making US$300,000 or less. What I would point out there is that 85 percent of Americans make less than US$200,000. 60 percent of those households are eligible for overtime. So, you have a situation where I think households will be able to take advantage of that. And that could serve as a quasi-sort of transfer payment. And then also with the child tax credit, that goes from US$2,000 to US$2,200. Not dramatic, but nonetheless, it's still, I think collectively could serve as, I think, a boost when we get into 2026.
TG: We don't want to get too political here, but I think the main controversy ahead of this bill's passage was the savings that were attained through cuts to Medicaid. And here again, it's dependent completely on who you read as to whether these will be significant or not. I mean, do they provide meaningful savings? First and foremost, is this a potential hit to demand if consumers health care costs, which, you know, healthcare inflation has been, I think, relatively stable since you had the ACA passed by Obama. But nevertheless, healthcare costs are high.
Does that potentially introduce a weight? How do you assess that?
ND: The total amount they achieve from Medicaid cuts I believe was mid like US$153 billion if I'm not mistaken. So that is, that's not pennies. I mean that's nothing to frown at. But you know, I think obviously the controversy part of it is that it's going to impact, it's going to require a work requirement or they have to volunteer, I think 20 some odd hours to become eligible. So they did try this in Atlanta or Georgia if you will. And they've had mixed reviews.
The anecdotes you get from there, because there's not really a lot of good quality data or results from it, but is that it made it more difficult for poor people to get access to healthcare. It's not going to impact families with kids, people with disabilities. So a large majority of people who need the care will still get it. But the controversy of course is how well or how physician are the most vulnerable to be able to fill out the paperwork or go through the red tape if you will, to achieve healthcare. And that is very difficult to answer if I'm being honest with you.
TG: Yeah, I mean not nearly as serious a concern from a humanitarian perspective, but I think the concern for markets as well. And this actually, actually is not something that I think is too controversial to talk about because I think Republicans, and especially certain types of Republicans, fiscal conservatives will talk about the nature of budget deficits and how this does bloat the deficit or continue the process of having bloated peacetime budget deficits.
The thing that's really struck me is in this bill's passage just how relaxed bond markets had been, we've heard for months really since Trump's probability of winning the election I think went above 50 percent that he was likely to be the heavy, the heavier spender of the two candidates for president. And yet bond markets seem relatively relaxed. And so on this question of oh, we need to assign additional term premia to long end rates in the US or just rates generally because now they are talking about issuing shorter term debt similar to what Biden was doing. That has not really come to the fore. The bond market vigilantes, their bark seems to be a little bit worse than their bite so far.
What do you make of this? Is all the fiscal expansion element of this in the price now?
ND: I think a lot of it has been priced in. I guess if we take a step back, if you look at dynamic scoring, I think the estimate is that it'll According to the CBO will cost over US$3 trillion over the next decade. We like to look at it just Conventional scoring, just to be conservative, that gets you to about US$4.5 trillion over, over a decade. So about US$450 billion per year. So I think the initial shock of the total amount this would add to the deficit, I think that is priced in. Now where I think we are is will this actually generate growth? The CBO projects about 1.8 percent growth over the next decade. The jury is out on whether or not this will be able to get us to grow above Trend, above that 1.8 percent. And that's important because the number to look at that I think the bond markets will be closely focused on is the deficit as a percent of GDP ratio, which is currently at about 6.2 percent.
My base case is that I think this will actually help the US to grow above trend. I think the projections are that it would add at least 8/10 of a percent of GDP for 2026. So I think it's possible that the deficit as a percent of GDP could actually get lowered to closer to 5 percent by the end of the of 2026 and go even lower from 2027 and beyond. So once we see that clear bend and that in that sort of deficit to GDP curve, I think that'll give the bond market some confidence and I actually think that could help to keep a lid or if not even push rates lower I think with, with longer term debt.
TG: One of the other aspects of this is that you get the benefits today, but the pain a little bit later and particularly and perhaps cynically after the midterm elections is when some of the spending cuts come into play. And again, I don't think that's necessarily a controversial point to make. That is kind of the facts of the bill.
How much of a future drag on growth might those cuts be? Are we talking about above trend growth for the next year, year and a half, only to see the payback in future years or is it kind of consistent over that 10 year forecast? Equalizing?
ND: Yeah, no, I think it'll be consistent because the biggest boost to the economy will come from the corporate side and the benefits for business, you know, it will encourage businesses to either do one or two things, I think, you know, increase cap capex or you know, actually increase hiring. You know, I don't, I don't expect those cuts to really drag on growth. I think they start to lapse like the, for example, the no tax on tips or overtime that lapses in 2028. But I think that the question is what will, what would the next administration do?
You know, it's very difficult once something's in place to take it away from people. So I have a strong sense that the next administration will continue on with some of these provisions that are not permanent. I think the growth we'll have by then will be enough to counter, absent any exogenous shocks, counter any of those cuts in the latter part of the decade.
TG: Well, this brings up the politics of it. You talk about the next election and actually even before then. I mentioned earlier there are of course fiscal hawks on the conservative side in particular. But there is now a lot of pushback, particularly from Elon Musk and this discussion of a third party, the America Party, that might run candidates to challenge some of the less fiscally conservative members of the Republican Party or to challenge Democrats themselves.
How credible is a third party threat, not just to the Republicans, but to but to the system overall, the two party system. And what effects do you see this potentially having on the 2026 midterms?
ND: So I don't think the way the US is structured with the two party system, a third party running and being successful at the presidential level is credible. Where it could be effective, of course, is in the Congress. And I do think it's possible to have an independent person emerge in the Congress, you know, and take and take some of the seats that are up for grabs. And the Republicans are very vulnerable in the House in particular. So they currently have 220 seats. They only can afford to lose two seats to maintain the 218 majority. They have five seats up for grabs in Colorado, Pennsylvania, Iowa, New York and Nebraska. So they're very vulnerable there. I think the Senate is a little less vulnerable, but nonetheless, I think it does pose a major risk as it relates to the balance of power in the Congress. But for the presidency, I don't think that it's credible for a third party to emerge and win, but it could hurt, I think, the Republican.
TG: Just thinking about the market impact of this now, and we talked about yields, but I was wondering if you could think about this topic of fiscal spending, fiscal expansion, deficits. We have a market narrative map that's produced in partnership with our friends at MediaStats. And just as we start to segue to some other topics that I wanted to talk about with respect to this narrative map, let's start with fiscal concerns.
We mentioned the relatively relaxed nature of bond markets, but does this fiscal story matter for some of the markets that we capture within the narrative map, particularly the dollar and US Equities? Is this really a relevant story that we need to think about? Now that the bill is passed and we can all move on, does it have a lasting market impact?
ND: We looked at various topics, not just the fiscal budget. We looked at trade, we looked at geopolitics. And out of the categories or narratives that we looked at, the one area that we saw a pickup in intensity and sort of negative sentiment towards was the topic of the fiscal budget. And it seems to be one of the more important factors driving gold prices and the dollar. And that actually supersedes, in that case, the Fed, actually. So that was kind of striking to us. And the narrative that was least impactful to those, to those, to gold and to the dollar was actually trade, the narrative for trade. So it seems like where we end up from a fiscal perspective is certainly going to have, I think, an impact on, on those asset classes with equities.
It was actually the Fed was the primary driver, but in the close second was the fiscal budget. So, so this is, we probably, you know, that tells us that we possibly could be at a crossroads with the budget. So this is a gamble, you know, the Trump administration is taking. They have to get, like I mentioned before, that deficit as a percent of GDP. They got to get that under control. If they don't, it could have consequences, I think, for, like I mentioned, possibly the dollar. You get a higher bid in gold, and then it could, it could have an adverse impact on equities ultimately.
TG: So that's really interesting. I mean, I wanted to talk about trade because, of course, this is a big week for policy and trade is coming to the fore again. We had the Liberation Day tariffs on April 2nd of this year. A week later, we had the backing down from those tariffs or the deferral of them in large part. But most of the reciprocal tariffs or all of the reciprocal tariffs were deferred, and many of the other tariffs were also deferred until this week, July 9th.
But now, and this might well change by the time this is published and goes out on Thursday. But now we have some more deferrals, but we have other letters being sent, particularly to Asian economies, to economies that have a high alignment with China, it has been noted, are receiving letters of similar tariffs to what were announced on Liberation Day, and markets are responding to this. But you're noting from the market map, the narrative map, that it's not a factor.
Do you think that's maybe underplaying the risk a little bit?
ND: To be honest, I think there is some complacency, but to be fair, I think it's what you earlier described, which is the so called, “TACO” trade. You know, “Trump always chickens out,” if you will, or to be politically correct, he reneges on threats that he previously made. Markets have embraced that sort of notion that, you know, he kind of does the shock and awe and then sort of backs down. To be fair, you could argue he kind of did that overnight where he sent out a number of letters, were pretty high tariff rates to places like Japan, Korea, so on and so forth. But then in a press conference, he basically said he's open to talks. And then he extended. He signed an executive order to extend or will sign an executive order to extend the tariff deadline to August 1st. So I think markets have caught on to this notion that, you know, he's looking to negotiate, and he’s sort of playing hardball. So I think, again, I think there is complacency. You know, I don't think the risk is zero, but I understand why there's that complacency because, of course, the actions of the administration have been, to be frank, kind of all over the place. And, and there's been an impetus to sort of back down from earlier maximalist sort of threats.
TG: I mean, after all is said and done, and this is a question I've asked other guests, and it's really an impossible question to answer.
But given what you think he's aiming to achieve with tariffs, what do you think the end state of this looks like? What are the aims and what is the sort of, as close as you can estimate the final answer as to what tariffs will look like?
ND: Again, trying to get into, like you said, it is impossible trying to get into Trump's brain is, you know, I don't think anyone has that ability. But I think originally he probably came into it looking to re industrialize, but I think he was faced with the reality that it's just too, you know, we're just too globalized to interconnect it. So now I think the step down from that was to try to achieve market access to a lot of these different places and have some sort of tariff level where we're getting, you know, at least some level of revenue. The sense I get is that they would like to get to an effective rate, probably between 10 to 15 percent, and that'll, you know, that'll help to, you know, offset some of the fiscal spending. My sense is that the administration would be comfortable with that level.
TG: Do you think China gets as favorable treatment as that? I mean, speaking of interconnections, in a globalized economy, so many parts of the supply chain run through China, if not wholly, at least in part.
How do you see the effective tariff rate on China evolving?
ND: Yeah, so effective tariff rate doesn't mean everyone gets the same tariff rate. So that's basically, I would say an average effective tariff rate. I think China is going to, I would be surprised if they go down from current tariff levels, which I think they have 30 percent from this year and about 25 percent from the previous administration from, from his, from Trump's first term. So I think that's going to stay in place because of just the competitive nature of the relationship. I think other countries, I don't want to speculate, but I think there's going to be other countries that are, they may have 25 percent, 20 percent. By no stretch do I think it'll be an even sort of across the board, 10 to 15 percent. I think that will be the average. But some countries will get treated better than others.
TG: Just finishing with the economic costs of this and then the political costs that might potentially arise from this. I mean, so far as our price stats work has shown the pass through primarily from China, because tariffs weren't as deferred on them as they were for other countries, the pass through has been relatively limited. The economic costs seem to be manageable. Do you think that lasts? I mean that effective tariff rate of 10 to 15 percent is at least a tripling of what the effective tariff rate prior to Trump coming in for a second term was. So it's a cost to bear. Does it represent a meaningful hit to demand and does it represent a meaningful hit to its popularity? This is ultimately a policy that I think a lot of people are in favor for or see some sense in.
But do the costs economically start to weigh politically at any point?
ND: The costs will eventually show up. I think what, what's happening now is that a lot of retailers in particular, I think front rank the tariffs. So in other words, they built up very wisely their inventory in Q1 in anticipation of higher tariffs. And then keep in mind, since the delay, we've only had on average about 10 percent tariffs. So I think they've built up their inventory and they're working their way through it. Now when we start to get into, I think Q4, we could possibly start to see some of that translate over to the consumer. The question is to what degree typically when you have these tariffs would happen or traditionally would be the US dollar would actually appreciate. That's what happened in the first term. We've actually had the opposite.
So any sort of counter to a pickup in tariffs from the currency, I Think that's been eliminated, unfortunately, you know, foreign countries, I'm not sure how much of that they will eat and then obviously not sure how much the importers will eat. As it relates to their margins. There's only so far they could go. So just mathematically it, it seems like it should, you know, should lead to higher cost of goods prices. Now there's other factors of course, like things like energy. So energy prices have obviously come off significantly, gas prices, and that actually translates into goods prices because companies have to pay for things like transportation and they factor that into their cost of goods. So ultimately we think there'll be some translation to inflation, there will be an increase and then that I think will impact clearly the bottom two quintile of income earners. It will impact some of the red states disproportionately. So for example, Montana, 93 percent of their imports come from Canada and Mexico for example. So they're clearly going to be impacted. Michigan, 70 percent of their imports, key swing state get, you know, are from Canada and Mexico for example.
So, Trump supporters are going to feel that price hike again starting I think as early as Q4. I think that will politically first hurt the, you know, House members, the Congress, the people running for Congress initially. I think it could actually hurt the Republicans when it comes to 2028. Whoever the next person in line is, I think could be negatively impacted. So it will, it will have political consequences. And also one last point I would say is even if we get to say 2 percent inflation, you know, households focus on the level. And I think even if you have a one-time sort of increase, that one time increase will linger and that will, and that's what consumers have to deal with.
TG: Well, there's a lot to think about. There's been a lot that's happened this week. It sounds like there's a lot more that we need to think about and assess as it all comes in. As ever, it's been great to get your takes, especially on the political side. I always love hearing your thoughts on where the risks are, who's vulnerable, who stands to gain, who stands to lose. We'll have to pick it up again when we figure out what the politics of this all means in a few months’ time. But thanks so much for joining us this week.
ND: Yeah, my pleasure. It was fun. Thank you.
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