The big & beautiful US budget bill passed last week in US House adds on to the fiscal deficit worries for US. While in itself, the bill adds 2.5 TN USD to fiscal deficit in the next 10 years, bond vigilantes issue lies in the fact that most of the tax cuts are upfront and cost savings are later during 2028/2029. They believe future lawmakers are likely to face pressure to extend those cuts again when the time comes and hence the fiscal deficit never comes down. While April tariff collections are strong at 20 BN USD, but it remains to be seen whether it remains the trend. Even assuming the 200 BN USD tariff collection, it will come either from reduced corporate earnings (if companies do not pass on the price increase) or in reduced consumer spending (if prices do increase and tariffs ultimately becomes taxes). Either way, there will be a -ve impulse on US GDP leading to lower revenues. Net impact hence will still be a 2 TN USD increase in US fiscal deficit over the next 10 years. Bond vigilantes have taken the 30 year US bond yield to close above 5% last week. Given the fiscal worries, term premia account for a large share of this move. While inflation expectations have also risen recently, real yields have been the primary driver. The repricing that has happened in the bond market will have consequences for the real economy. Interest rate expenditures will rise for the government, as well as the private sector, reducing private investments (crowding out). Running large fiscal deficits (ie, low public savings), especially in situations where the economy is already growing above potential (ie, cyclically adjusted), is thus a policy that adds to an external current account deficit. In major advanced economies, US now runs the largest twin deficit (ie, a combination of a primary fiscal and external current account deficit). Bond vigilantes don’t like such high peace time fiscal deficits and are expected to test Trump’s resolve by pushing bond yields higher. So, we continue to believe that it will get worse before it gets better. We continue to expect to see 4.85%-5% yield on 10yr UST in near term.
