The potential implications of Donald Trump’s tax and spending bill, which passed the House of Representatives yesterday by a single vote are discussed in detail below. Whilst the repercussions might be severe, investors put on a brave face yesterday and possibly took heart from the weekly initial jobless claim report, which showed a small decline suggesting a resilient labour market. Further encouragement came from improved US business activity this month as the Composite PMI which reflects on the health of the manufacturing and the service sectors rose to 52.1, up from 50.6 in April. In a notable development, import tariffs raised prices for companies and consumers implying renewed inflationary pressure.
Economic data helped equities to stabilize, which, in turn, supported oil to recover some of the losses registered during London morning. The brief but fierce sell-off was the product of OPEC+ discussing the third consecutive rise of 411,000 bpd in production in July, triple the original plan, first reported by Bloomberg. At this rate, the 2.2 mbpd unwinding of voluntary output constraints will be completed by September considerably loosening the oil balance and leading to a sharper-than-expected swelling of global oil inventories. Re-gaining lost market share and punishing disobedient members, namely Kazakhstan, has taken priority over supporting oil prices. The move, if confirmed after the next meeting scheduled for the very beginning of June, will further sour the palpably grim sentiment.

OBBBA

The aphorism, credited to John F. Kennedy, that a rising tide lifts all boats has become one of the cornerstones of supply-side economics. It suggests that everyone who participates in the economy enjoys the benefit of investing in it. It is the quasi-synonym of the theory of ‘trickle-down economics’, which states that lower taxes for the wealthy and deregulation serve the well-being of the entire population. More socially sensitive economists would argue that they lead to a widening inequality gap, an inauspicious development for the economy, simply because the rich are less likely to spend their wealth supporting growth than the poor. It is these two contrasting schools of thought that are clashing in the eccentrically titled ‘One, Big Beautiful Bill Act’, the flagship tax and spending legislation of the US Administration.

The bill, more than a thousand pages long, will have a tangible and direct impact on US economic growth expectations and investors’ sentiment since government spending is an unalienated part of the formula that measures the combined value of goods and services. In the latest development, the Republican-controlled House of Representatives passed the bill with a razor-thin majority of one in the early hours of yesterday despite initial opposition from the members of the House Freedom Caucus, who wanted to include additional spending cuts. It will now progress to the Senate, also controlled by the Republicans. Once it is supported by the majority of the upper chamber it will arrive at the Resolute Desk where President Trump will sign it into law.

The main points of the bill are as follows:
-          Extending a smorgasbord of tax cuts passed during the first Trump term in 2017 expiring at the end of the year, including income tax cuts and increased child credits.
-          Eliminating taxes on gratuities and overtime pay.
-          Increases in estate and gift tax exemptions.
-          A broad range of business tax breaks.
-          Rising taxes on investment income from universities and private foundations.
-          Cutting almost $800 billion from Medicaid and hundreds of billions from food stamp programmes and clean energy tax credits.
-          Providing $50 billion to border security, including completing the wall along the Mexican border.
-          The originally planned tax increase on the hedge fund and private equity industries will not be included. The ‘carried interest loophole’ will remain intact.

According to the official narrative, the bill only cuts ‘waste, fraud and abuse’ but amounts to nothing meaningful. The White House press secretary was at pains to explain that it would not lead to a ballooning budget deficit, something that non-partisan researchers and the market respectfully disagree with. The Committee for a Responsible Federal Budget projects a jump of $3.3 trillion in public debt by 2034 if the bill goes through. When considering that several deficit-increasing provisions will end in 2028 and deficit-reducing provisions will not begin until after that year, the amount climbs to $4.8 trillion. It currently stands at $36.2 trillion. The debt-to-GDP ratio would surge from 98% to 125% as opposed to 117% under the current legislation. The annual deficit would escalate to 9% of the GDP, up from 6.4% presently. These estimates are in stark contrast with the government’s prognosis of halving the fiscal deficit to 3% by the end of the current term, boosting real growth to 5.2% and creating 7.4 million jobs in the next four years.

Inflating public debt needs to be financed and it usually happens by investors lending money to the government. The initial reaction of the bond market was ominous. Yields on the 10-year Treasury bond briefly rose above the post-Liberation Day peak of 4.59% yesterday and peaked at 4.63% before easing. The bigger the perceived damage the OBBA causes the higher yields bond vigilantes will demand making it an increasingly challenging task to finance the deficit. Debt interest payments at $880 billion last year already topped Medicare and military spending. It seems that if the bill is enacted into law, the odds of the US government regaining the trust and confidence of investors and the wider public will suffer a fatal setback. The repeat of the early-April market reaction of falling stocks and bonds together with the weakening of the dollar could lead to a severe capital flight out of the US with all its ghastly economic and political consequences from which oil would not be inoculated.

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