Where are we on US budget process?

Introduction: Welcome to Eyes on the Economy by CIBC Capital Markets, a podcast series dedicated to addressing current issues in a concise format, helping to make sense of the evolving economic complexities, so that you can take action.

Ali Jaffery: Hello everyone, welcome to another episode of Eyes on the Economy. I’m your host, Ali Jaffery, and I’m joined by our Chief Economist, Avery Shenfeld. Today we’re going to talk about a piece Avery wrote last week about US fiscal policy and what investors need to know. I should mention also that we’re recording this on Monday, March 3rd, a day before the president’s major speech on Tuesday night. So we’re temporarily turning away from tariffs until we know exactly the path of trade policy. So Avery, tell us, where are we in the budget process?

Avery Shenfeld: Well, we’re in a bit of a state of limbo right now. We have to, of course, get ultimately a bill signed by both the House and the Senate and then approved by the president. And at this point, the House and the Senate are on very different paths. So the Senate has passed a bill which really only addresses the need for additional funding for both border issues, so all those deportations are costing money, as well as beefing up by U.S. defense spending, but doesn’t really do anything on the issue of tax cuts or the broader issue of the need to balance tax cuts against overall expenditures. Meanwhile, the House Republicans have focused on a single bill designed to not only allocate resources towards some of those priorities like immigration and tightening the border, but also funding the tax cuts with some offsetting spending reductions. So these are two very different bills and a lot of gaps actually remaining even in that House bill, which is supposedly comprehensive, but has a lot of blanks in it.

Ali Jaffery: So tell us, Avery, what does the House bill actually contain?

Avery Shenfeld: Really, it just sets out the amount of money that they’re prepared to set aside for tax cuts, that’s 4.5 trillion over 10 years, and then sets out some minimum spending reductions designed to offset a chunk of that with some hope that economic growth implications of this will fill in the remaining gap. So it’s all about minimum spending cuts, which are not actually detailed other than by House committee. So different areas of spending are allocated a minimum reduction, but there’s nothing in the bill that says we’ve agreed to reduce these specific things by these specific amounts. And they’re really only minimum reductions. So some of the hawks on spending have left themselves room to argue for deeper cuts than are in this, this basically a framework bill rather than an actual budget bill.

Ali Jaffery: So then what is the implications for the Fed from what you’ve seen so far?

Avery Shenfeld: So what the Fed will really be concerned about is what happens in the next couple of years in terms of the degree of fiscal stimulus. Remember that they’ve paused on rate cuts, partly because inflation has looked a bit sticky, but partly because they just don’t know what the combination of the Trump administration and Congress will do on spending items. If you get enough tax cuts, for example, kicking in in years one and two, and spending cuts kicking in five to 10 years from now. That’s going to add stimulus, add to inflation pressures, and make further interest rate cuts completely unnecessary, or even in the extreme, I suppose, force the Fed’s hand into hiking again. As it stands right now, we don’t really see anything in this framework that closes the door to some rate cuts resuming later this year, given what level of detail we have. So the tax cuts in the bill actually aren’t tax cuts. They’re just maintaining current tax rates that would otherwise have climbed. And that 4.5 trillion ceiling of tax savings actually doesn’t really leave any room for any other tax cuts. So if this bill ends up being the final bill, then there really wouldn’t be any tax cuts, just not tax hikes, but spending cuts would be kicking in. So overall, we might actually get a little bit of a drag on economic growth, which is a reason why in our own forecast, we’ve retained some room for some modest Fed rate cuts in the latter half of the year, if that’s how it ends up being in the final bill.

Ali Jaffery: Interesting. So what’s the read for the bond market then?

Avery Shenfeld: Well, the bond market doesn’t just care about the next two years, it really does care about what’s the medium term outlook for budget deficits and therefore for Treasury financing requirements. And this bill really isn’t great news for that, but it’s probably not worse news than anyone was counting on. So if you actually look at what they’re saying about budget deficits relative to the status quo, it’s a little bit worse in the first couple of years and a little bit better further out. So the CBO outlook would have budget deficits climbing to two and a half trillion by 2035. This bill claims that deficits will basically just hover near $2 trillion a year. So basically staying flat over the next 10 years. Now, there’s a bit of a trick there. One is they’re assuming that because of this wonderful economic policy mix, economic growth will be faster than the CBO assumed. And there’s reasons to be a bit skeptical there, both because in the past that hasn’t always worked out, but also because we’re starting from an economy that’s pretty close to full employment, populations going down. It’s going to be hard to squeeze out that much extra economic growth. And then the other factor is that we don’t really know what the spending and tax cuts are going to be year by year because the way they lay out the tables for this bill, the tax cuts are the same 4.5. The 4.5 trillion is allocated evenly over 10 years. But of course, as the economy grows, lower tax rates will be more costly as GDP goes up and the overall revenue base goes up. That tax cut is worth more. And also because the spending cuts are really allocated evenly across 10 years, we again don’t know if that’s the case. But our view is that there’s nothing really in here that should surprise investors in the sense that nobody expected a major assault on the budget deficit from this administration. Just have to look at what Trump did in his first term to get a sense of that. I think where there are issues for the bond market is whether we believe that they can actually come up with these spending cuts that they’ve allocated. Because if you look at the line-by-line items that they do lay out, it would appear that a lot of the money has to come from a House committee that really is responsible for both Medicaid and Food Aid for the Poor, what we used to call food stamps. And there are moderate Republicans who are opposed to that. So can they get the votes for that? If they have to come up with other spending cuts, the question is, can they really get the votes for those spending cuts? And it is going to be a battle between fiscally conservative Republicans who actually want to cut more and more moderate Republicans from states that are closer calls between Democrats and Republicans. who won’t want those deeper cuts. So we’re still going to be a bit skeptical that this bill is the ultimate and therefore there’s still some risk to the long end of the bond market if budget deficits don’t stay under reasonable control. But the reality is, as I said, we were never really counting on big fiscal restraint over the next four years. And I don’t believe the bond market was either. What we’ve seen, of course, in recent weeks is a rally in the Treasury’s market. And the first leg of that was the market actually reducing its fears that we were going to have huge budget deficits. And now more recently, of course, there are some concerns about the pace of US growth in Q1. So we’ve had a bit of a further rally at the long end and some weakness in equities helping that. So I think the big concern for now isn’t really about budget deficits, it’s about the inflation from tariffs, where the economy is going, and we’ve sort of put this budget issue aside. But we wrote this letter or this note in part because we are facing some key deadlines. Mid-March, we need to pass some sort of spending bill or the government shuts down. There’s still that debt ceiling issue. And of course, the Republicans and the Trump administration want to get going on the tax cuts.

Ali Jaffery: That’s a good place to stop. Thanks for tuning in and we invite our listeners to read the piece on CIBC Economics website along with our other research. Until next time, we’ll be keeping our eyes on the economy and calling it like we see it.

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