Institute Alert

• We expect fluid trade policy and a contentious budget debate in a closely divided House and Senate to produce market-moving events in July and August.
• This report is intended to help investors track the main issues related to each event and their potential capital-market impacts.

• As economic and policy uncertainties are likely to foster bouts of near-term market volatility, we prefer a disciplined approach to portfolio adjustments, as detailed in our 2025 Midyear Outlook: “Opportunities amid uneven terrain.”

As we approach the second half of 2025, a trifecta of potentially market-moving issues is set to emerge: the end of the 90-day pause on reciprocal tariffs and the two congressional decisions to finalize a federal budget and to raise the debt ceiling. Large uncertainties surround all of these issues. First, there has been little sign of progress on bilateral tariff negotiations, and the delay has prompted U.S. threats of unilateral tariff increases. The Trump administration may extend the pause more selectively for countries in serious negotiations, but the administration has yet to reveal which countries may qualify for any further extensions. We think it likely that at least some of the April 2 reciprocal tariffs will apply, and that should create pressure on the U.S. economic sectors in the form of higher prices, lower corporate profits, or reduced business investment.

The budget bill and the increase in the debt ceiling are related decisions. The larger the budget’s deficit projections over the coming 10 years, the larger the debt-ceiling increase. The spotlight in the budget debate shifted to the Senate this month after the House version of the bill squeaked by with a one-vote majority on May 22. We believe that the One Big Beautiful Bill Act could be debated until the end of July, just ahead of an approaching August deadline for a debt-ceiling increase. The debt ceiling’s looming X-date (when the Treasury is no longer able to meet all its obligations in full and on time) and the high priority on extending the 2017 Tax Cut and Jobs Act (TCJA) make a compromise bill by the end of July highly likely, in our view. Timing will matter for market reactions. The pause on most reciprocal tariffs expires on July 9, and for China it expires on August 12. These dates bookend the budget and debt-ceiling legislation that we expect to pass by the end of July.

We highlight several key issues to watch as the trifecta of market issues progresses:

Tariffs set to recapture headlines

Since the U.S. reached a temporary tariff truce with China in early May, the only other real bilateral trade accord has been an initial framework deal with the U.K. Beyond that, little progress in talks with such countries as India, Japan, and Vietnam has prompted U.S. threats of unilateral tariff increases when the freeze on reciprocal tariffs above a 10% universal base rate is lifted on July 9. Taken together, we think that these and other product-specific tariffs now under consideration will leave the U.S. with historically high and potentially debilitating levies. We expect the brunt of the tariff impact to wash ashore during the third quarter, coinciding with a drawdown in inventory stockpiles that had been built up ahead of tariff announcements early this year and producing an inflation spike, ultimately slowing economic growth.

An added wrinkle in the tariff outlook is that the U.S. Supreme Court may decide against two-thirds of this year’s tariff increases enacted under the International Emergency Economic Powers Act, despite a favorable ruling in a 1975 precedent. In this event, however, we believe the Trump administration would fall back on other trade legislation restricting actions to product- or country-specific tariffs under either the 1962 Trade Expansion Act or the 1974 Trade Act (or perhaps the less-discussed 1930 Smoot-Hawley Tariff Act). This more piecemeal approach still would further the president’s broader focus on encouraging manufacturing reshoring, narrowing trade deficits, and boosting tariff-related revenues. While lumpier tariff implementation using this approach might delay or limit the economic slowdown we anticipate in the coming months, it would do so at the risk of prolonging the inflation impact beyond a one-time summer shock.

Debt ceiling creates deadline at end of July

Imbedded in the budget bill is a $4 – $5 trillion debt-ceiling increase to accommodate expanded government borrowing for the next two or three years, according to estimates by the Congressional Budget Office (CBO). The need for a new debt cap creates a hard deadline at the end of July for budget reconciliation, just ahead of Congress’s August recess and the projected X-date. A less likely alternative would be a separate, temporary debt-ceiling increase to cover the August recess period and its aftermath, leaving expiration of reconciliation authorization on the September 30 fiscal year end as the next hard deadline. In any of these cases, we think it highly likely that Congress will raise the debt ceiling. However, the closer to the September 30 fiscal year end that lawmakers act, the more likely bond yields are to rise and the U.S. dollar to weaken.

Balancing tax and spending cuts

Extension of the TCJA for another 10 years, costing close to $4 trillion, is the centerpiece of the GOP’s reconciliation bill and the impetus for getting compromise legislation across the finish line. Other tradeoffs likely will be more contentious. The Senate proposes comparatively deeper cuts to Medicaid spending to provide the savings for smaller, more gradual cuts to renewable energy tax credits — particularly for electric vehicles as well as wind and solar energy — than those proposed in the House version of the bill.

The Senate’s plan also maintains the current $10,000 state and local tax (or SALT) deduction (per tax filer) as a placeholder for further negotiations, which would finance permanent business investment tax breaks (including full expensing for equipment, factories, and research-and-development investment along with expanded business-interest deductions). The House version allows a $40,000 SALT deduction but restricts business investment tax breaks to only five years (expiring in 2029 but retroactive for 2025). The tax deduction for qualified businesses — of particular benefit to small businesses — was maintained in both versions of the bill but increased to 23% (from 20%) in the House proposal. The devil also is in the details in how each chamber maps out the increased standard deduction; child tax credit; tax exemptions for tips, overtime, and car-loan interest; and the increased deduction for senior citizens.

Eying Section 899

Section 899 would impose annual 5% tax increases (capped at 20% in the House bill compared to 15% in the Senate bill and with a delayed 2027 start) on foreign-owned businesses in the U.S. whose home countries impose digital, minimum, and other taxes on U.S. multinationals viewed as unfair by the White House. Importantly, Section 899 proposals in both chambers retained the Portfolio Interest Exemption (PIE) exclusion, exempting the dominant U.S. Treasury and corporate-debt markets and easing our concern over the potential systemic impact from discouraging foreign investment in the U.S. So far, the provision’s objective appears to be truly retaliatory, targeting countries rather than raising revenues materially beyond the estimated 10-year increase of $116 billion now projected by the CBO. Systemic risks posed by a potential PIE repeal and the nebulous definition of unfair overseas taxes could encourage a foreign pullback from U.S. securities purchases serious enough to weigh on the U.S. dollar, depress U.S. Treasury prices already at risk from mounting deficits, and ultimately undermine the dollar’s core international-currency function as an investment vehicle in international finance.

Checking in on the deficit impact

The CBO estimates that the House reconciliation bill would lift government deficits to an average 7% of gross domestic product (GDP) in fiscal-years 2026 – 2028 — an increase from 6.4% in fiscal-year 2024 and a big jump from the two-decade average of roughly 3.5% before the coronavirus pandemic’s onset in 2020. On paper, at least, most of the added $2.8 trillion to budget deficits over the reconciliation bill’s required 10-year projection period would be offset by higher tariff revenues and a planned 10% targeted cut in federal employment, neither of which are included in the reconciliation bill because they have not been legislated by Congress. We believe that increased tariff revenues likely will offset much of the reconciliation bill’s projected deficit increases, regardless of any future court ruling on existing tariffs, because of alternative trade legislation available to the president to pursue his trade-policy goals.

Capital markets typically try to predict policy outcomes, but the potentially large impacts of this trifecta of issues could present forecasters an especially great challenge in the coming weeks. Unexpectedly modest tariff increases or a budget deal suppressing deficits and limiting the rise in Treasury debt are capable of supporting the U.S. dollar’s exchange value, propelling commodity prices and U.S. equity values, and blunting the rise in fixed-income yields. However, trade and fiscal policy cuts both ways, leaving the dollar, commodity prices, and stock and bond markets exposed if policies result in higher tariffs and deficits. Section 899 deserves special attention as possibly a new weight on fixed-income prices and the dollar’s value. Yet, the magnitudes of these market moves may be smaller than those in early April because of the economy’s positive momentum and the three months that investors have had to price in the possible tariffs and deficits.

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