Fiscal Headaches

The US equity market saluted the concessions offered by the White House to China at the beginning of last week, although the overall tariff shock remains very large. The new focus on fiscal policy – materialised in the “One, Big Beautiful Bill” endorsed by the House’s Ways and Means Committee last week – and its additional tax cuts for businesses and households may explain some of this optimism. Yet, independent sources suggest that if it was implemented in its current form, the bill could push the deficit towards 8% of GDP. Moody’s decision to downgrade the US sovereign rating is a reminder of the concerning trajectory of US public debt, while the introduction in the bill of a withholding tax on US financial income accruing to non-residents could add to the risk premium now embedded in US long-term yields. Now, the Ways and Means Committee was only one step along the complex “reconciliation process”. Even after passing the House – which as we write is not certain, given lingering divisions within the Republican caucus – the Senate could still amend the text. Getting the House and the Senate to vote the same terms for the legislation by 4 July – the initial target – looks daunting.

By contrast, policy predictability has become a European asset, even if political stability is not a given there. Yet, despite very recent challenges, mainstream groups are still in control: the far-right pushed further in the Portuguese elections last Sunday, but the centre-right is in position to continue running a minority government. In Romania, the centrist, pro-European candidate won the presidential elections. True, in Poland the centrist candidate to the Presidency will face a difficult second round, but the general policy stance in Warsaw, under PM D. Tusk would be little changed. Yet, beyond politics, outside Germany, policy space to support the economy remains scarce. We explore in some details the French case. Given the past trends in government expenditure, notably social spending, which stand out across the big European countries, significant restrictive measures will be needed to anchor the debt trajectory. This unavoidable shift will offset, for the Euro area as a whole, some of the German fiscal push.