> Republicans have only narrow majorities in both houses. They control 53 out of 100 seats in the Senate and 220 seats out of 425 seats in the House. This means they can only afford to lose three votes in the Senate as well as the House, where Democrats currently control 213 seats. (Two formerly Democrat-controlled seats are currently vacant. By threatening to withhold support, individual Republican House members have a significant degree of influence to shape legislation, making it difficult to reach agreement.
The budget reconciliation bill, if passed roughly in its current form, will help avoid a sharp increase in taxation next year when the 2017 Tax Cuts and Jobs Act (TCJA) tax cuts are set to expire, thus avoiding a significant shock to domestic demand and economic growth. Budget reconciliation addresses the expiration of several provisions of the (TCJA), originally enacted in 2017. The bill would avoid a sudden increase in taxes (so-called fiscal cliff), but it would do nothing, in fact in its current form it would significantly add to the government debt burden in the coming years. The budget reconciliation bill calls for $1.5 trillion in spending cuts and $4 trillion in tax cuts (scored against the current law scenario) The bill would extend Trump 2017 individual income tax cuts, increased standard deduction and childcare tax credit, cut taxes on tips and overtime pay as well as as boosting military and border security spending. The final bill will likely seek to rein in Medicaid spending (through stricter work requirements), reduce Biden-era green tech tax credits and increase the ceiling for state and local deductions.
> The Byrd Rule sets a budget window of ten years to limit the increase in government that can be enacted through budget reconciliation. The Byrd rule does not allow for extraneous provision to be included in legislation. Legislation is considered extraneous if it does not have a budgetary effect, if the budgetary effect is merely incidental, the effect is outside the jurisdiction of the committee recommending it, the effect is not what the original provision calls for, the measures affect social security spending and, importantly, it increases the deficit beyond ten years.
> The baseline budget deficit projection is based on federal spending and revenues under current budgetary practices. The current policy scenario assumes that all policies are extended, even if certain provision are set to expire, such as many TCJA cuts. The costs of the bill are calculated based on current law policies. According to the Congressional Budget office, extending the TCJA provisions, compared to current law, is projected to reduce revenues and increase deficits by nearly $4 trillion from 2025 to 2034. That is critical because a current-law baseline counts the extension of TCJA provision as a cost that, due to the Byrd rule (see below), would need to be offset with an equivalent of cuts to remain deficit neutral during the ten-year budget window.
If the budget reconciliation passes in roughly its current form, it will further accelerate the increase in federal government debt and is likely to put upward pressure on bond yields and government borrowing costs, while it may also be marginally dollar-negative. The government argues that the tax cuts, combined with economic deregulation, will pay for themselves. But tax cuts have never fully paid for themselves, and non-partisan agencies and think tanks project the federal debt-to-GDP to be roughly ten percentage points higher by 2035 than otherwise. This is likely to increase market concerns about the longer-term fiscal trajectory and lead to higher yields, but it is not likely to lead to significant financing challenges. The U.S. federal government has significant financing flexibility due to the breadth and depth of its financial, including treasury market and the international role of the dollar. But a significant sudden spike in yields may yet force the U.S. government to become fiscally more disciplined following the approval the budget reconciliation bill. Analysts and markets will become more concerned about the medium- to long-term fiscal trajectory if the bill passes in roughly its current form.
> Federal government debt held by the public amounted to 98% of GDP last year, compared to just 73% of GDP a decade ago, according to the Congressional Budget Office (CBO). The CBO projects federal debt to reach 116% of GDP in 2035 and 156% of GDP by 2055. This is before adding in the likely costs of the budget reconciliation bill.
> The non-partisan Committee for a Responsible Federal Budget estimates the legislation in its current form would $ 3.3. trillion to the federal debt burden (or roughly 10% of GDP,) or increase the debt ratio to 125% of GDP instead of 117% of GDP from its current level of around 100% of GDP.
> On Mary 16, Moody’s was the last international credit rating agency to strip the United States of its AAA sovereign credit rating. Standard & Poor’s had done so in 2011 and Fitch in 2013. Moody’s also forecast that the federal deficit would increase from 6.4% of GDP in 2024 today to almost 9% of GDP in 2035. The International Monetary Fund has called on the United States to reduce its deficits.
The short- to medium-term implication of the approval of a profligate budget reconciliation bill will be limited in terms of the international role of the dollar and the continued centrality of US treasury markets, provided the U.S. administration does not pursue other destabilizing policies. The U.S. treasury market is the largest, most liquid and most developed financial market in the world. A sudden breakdown of the market is unlikely, though increased volatility is possible. International investors have very limited alternatives. A worsening budget outlook may lead them to diversify further, but they will not aggressively dump the dollar and U.S. assets, as the deteriorating fiscal dynamics will lead to only a gradual, if persistent increase in U.S. government debt. Meanwhile, countries like China will continue to diversify their holdings, including through gold purchases and by moving into non-US-treasury assets. This will at the margin contribute to higher yields, and maybe a weaker dollar. But the degree to which investors and country can diversify their foreign assets away from the treasury market is somewhat limited. Alternative markets for safe assets are very small (Australia, Canada) or too fragmented (euro area) or even potentially more fraught with political and economic risk, in addition to being difficult to access (renminbi). Similarly, aggressive diversification out of the dollar by a country like China is also not likely. In addition to the above reasons, aggressive as opposed to gradual diversification would jeopardize trade negotiations, and if it were to lead to more serious market dislocation, lead to capital losses, a stronger renminbi, and it would risk a severe economic and political reaction from Washington. The most likely scenario is one of higher or high-ish yields on long-dated U.S. treasuries and possibly a weaker dollar, but no significant market dislocation, at least nothing worse than what U.S. treasury markets witnessed in 2019 and 2020 increase pressure on yields.
> in its April World Economic Outlook, the International Monetary Fund lowered its growth forecast for real GDP growth for 2025 nearly a full percentage point to 1.8% on the back of heightened uncertainty about U.S. trade policy.
> The yield on 30-year bonds temporarily exceeded 5% on Friday, following the Moody’s downgrade. According to the IMF, 59% of global foreign-exchange reserves are held in dollars and only 20% are held in euros. Renminbi holdings amount to only 2%.