Washington Watch: The House budget reconciliation act moves to the Senate while tariff income flows into the U.S. Treasury

On Thursday, May 22, the U.S. House of Representatives narrowly passed its budget reconciliation legislation, dubbed the One Big Beautiful Bill Act, by a 215-214 vote with one abstention. Fiscally conservative Republicans supported the revised bill which moved up the start date for new Medicaid work requirements and clean energy tax credit phaseouts, while increases to the state and local income tax deduction, or SALT, won over Republicans in higher income tax states including New York, New Jersey and California.

Federal budget negotiations and the debt limit

Penn Wharton Budget Model, one of many budget watchdogs, estimates the House-passed tax and spending bill would increase the primary deficit by $2.8 trillion over the next ten years, adding to the current $36.2 trillion in national debt.¹ “Rising interest expenses and expanding budget deficits are raising fiscal sustainability concerns for investors”, notes Tom Hainlin, national investment strategist for U.S. Bank Asset Management Group, with the average interest rate on the national debt rising from 3.0% in 2023 to 3.4% in 2024, while interest expense increased from $684 billion to $1.13 trillion over the same period.² “We view the 10-year U.S. Treasury yield as the market arbiter regarding budget deficits. One threshold we are watching as a potential fiscal stress indicator is the 5% level on the 10-year Treasury,” says Hainlin, which closed at 4.5% on Wednesday.

The House bill now moves to the Senate where Republicans hold an equally slim 53-47 majority, with several members indicating they want to make significant changes to the legislation. Any Senate revisions to the House bill would have to return to the House for approval before forwarding identical House and Senate verbiage to President Trump to be signed into law.

In addition to fiscal sustainability concerns, “the timing of the reconciliation bill’s passage is also adding to bond market volatility,” says Hainlin. Treasury Secretary Scott Bessent stated the Treasury will likely run out of extraordinary measures to repay U.S. government bond holders if the debt ceiling isn’t raised or suspended by August, known as the “x-date”.³ Republican lawmakers included a $4 trillion debt ceiling increase as part of the legislation, with Speaker of the House Mike Johnson setting a July 4 target date to enact the tax and spending bill into law and alleviate investor concerns about a potential U.S. default.

Trump’s tariffs pause

Meanwhile, businesses, consumers and investors continue to adjust to expected final tariff rates. On April 9, President Trump announced a 90-day suspension in 20% reciprocal tariffs on all imports from the European Union, leaving a 10% base tariff rate in place. The 25% sectoral tariff on imported steel and aluminum imposed on March 12 remained in effect, as well as the 25% tariff on imported automobiles and auto parts which took effect on April 2 and May 3 respectively. Following a Bloomberg report that the European Union (EU) submitted a revised trade proposal to the Trump Administration, President Trump threatened the EU with a new 50% tariff rate, accusing the member bloc of not negotiating reciprocal tariffs in good faith, and said the new higher tariff rate would begin June 1. After holding “a very nice call” with European Commission President Ursula von der Leyen, President Trump postponed imposing the 50% tariffs on the EU to July 9, the same date the 90-day reciprocal tariff pause is set to expire.

Treasury tariff income increased significantly in April and May to date, with April receipts increasing by $9.7 billion relative to 2024 while May increased by $14.9 billion through May 23, according to Bloomberg data. Treasury Secretary Bessent informally linked tariff income with the Federal government budget, stating at a 100-day press briefing at the White House on April 29 that tariff income “could be used” to fulfill President Trump’s campaign pledges of no taxes on tips or overtime while also extending and expanding tax cuts from the 2017 Tax Cuts and Jobs Act.

However, direct connectivity between tariff income and U.S. government finances remains uncertain. “Extrapolating two months’ data over a ten-year government budget window represents a major untested assumption,” says Hainlin. Higher tariff rates may influence economic behavior through the principle of the price elasticity of demand, which measures the percentage change in the demand for a good or service divided by the percentage change in price. Goods or services with readily available and acceptable substitutions exhibit highly elastic demand, meaning the demand decreases faster than prices increase. In this example, the Trump Administration may raise the tariff on a particular imported good by 10%, but if the importer or end consumer can easily substitute a non-tariffed option, the demand for the tariffed good will decrease, reducing or eliminating the anticipated tariff income.

Assessing potential tariff outcomes

“As we monitor consumer and business activity leading up to the reciprocal tariff pause expiration on July 9,” Hainlin notes, “we return to the three scenarios we have articulated to provide investors with a framework to gauge potential tariff outcomes.” These include the following:

• Positive case: Successful negotiations wrap up at or before their allotted times, with headline tariff levels below market expectations, and China/U.S. relations thaw. Supply chains allow for demand to be met, companies and businesses resume growth and central banks remain accommodative.
• Base case: Prolonged negotiations with positive momentum, headline tariff levels hovering between 10%-20%. Companies and consumers demonstrate gradual adjustments while trade negotiations continue, but growth remains positive. Asset prices trend within defined ranges, with pre-April 2 (tariff announcement day) levels important reference points.
• Negative case: Tariff negotiations go poorly (especially U.S./China), upending global trade and clouding other anticipated legislation. Headline tariff levels exceed 20%, business and consumer activity slows, and a recession unfolds as central banks offer minimal help. Riskier asset classes trend below April 2 levels.

Investment implications of Trump’s tariff pause

Recent market performance and announced tariff pauses between the U.S. and major trade partners China and the European Union suggest we currently reside somewhere between the base and positive cases. We continue monitoring 10-year U.S. Treasury yields for signs of potential fiscal stress, while tracking high frequency economic data along with corporate earnings reports to understand whether uncertainty is hurting business investment and consumer spending activity, which have to date remained resilient. While retaining a glass-half-full outlook for diversified investment portfolios, we still view a full range of potential outcomes within this tariff pause period, anticipating equity markets are likely to trade within a broad range as investors adapt to the changing tariff environment and its potential impact on economic growth.

Investors may wish to consider a balance between global equities and fixed income based on the attractiveness of higher interest rates and potential earnings expansion driven by still positive economic growth. Treasury securities and other fixed income investments should continue to play an important role in a broadly diversified portfolio. U.S. Bank will closely monitor the government’s increasing debt burden and policies that influence long-run sustainability for signs of change across the broader investment landscape. Consider talking with your financial professional to make sure you have a comfort level with your current plan and investment position.