Debt, Deficits & One Big Beautiful Bill

LIZ ANN SONDERS: I'm Liz Ann Sonders.

KATHY JONES: And I'm Kathy Jones.

LIZ ANN: And this is On Investing, an original podcast from Charles Schwab. Every week we analyze what's happening in the markets and discuss how it might affect your investments.

Well, hi, Kathy. I hope you had a nice little bit of a break over the Fourth of July week. We took a break from this podcast, and it's been another busy week. Of course, one of the biggest stories is what else? Tariffs. It seems to always be one of the biggest stories. And I guess the deadline is no longer today as we're recording this, but instead August 1st.

So let me just toss it to you. What is the bond market making of the news we've gotten in the last couple of days and how are bond investors thinking about this?

KATHY: I would say bond investors are just being very cautious. So yields were down a bit prior to the announcement that we were back in tariff mode. And they bounced back up as a result because tariffs are inflationary to some extent. And they also, we know, are a big reason the Fed is waiting to see if they can cut rates because they're waiting to model out what the impact of tariffs will be on prices. And without clarity around tariffs, I think Powell has indicated that they're pretty much on hold, so that got yields back up. But frankly they're still in a range. So the 4.40% area for 10-year Treasuries has kind of been a magnet over the last couple of months, would just move sideways. It's been some volatility around it, but recently it's actually kind of compressed into a tighter range. And I think that just reflects the fact that we're in kind of an equilibrium stage here, where inflation is not taking off to the upside, and it's made some improvement, but it's not really where it needs to be for the market to get really comfortable that we're heading to 2%, or the Fed to get comfortable. And the economy is going along a little softer, which would tend to pull yields down. But tariffs are sort of offsetting that, along with the fiscal policy offsetting that. So we're just kind of back and forth here, waiting to see what the next step is in policy. But I think as a kind of generalization, the Fed now looks to be on hold for quite a while until all of these policies play out.

We still see the room for a rate cut in September, but it really is going to depend on the labor market and how the tariff policy evolves and what the impact of some of the budget cuts and the budget expansion has on the market. But the overlay is that we know that we have a lot more financing to do for the federal government. We know that policy is still very much up in the air, in terms of tariffs. And that means, I think, that what we see, not just in the U.S., but globally, is a higher risk premium in bonds. And so everywhere I look, all I see is the scope for more risk premium, meaning extra basis points for investors to buy longer-term yields. So we still continue to look for that 10-year yield, 30-year yield, to kind of edge higher because you have to add in some extra yield for investors to say, "I'm willing to go that far out and commit my money."

LIZ ANN: You know, speaking of that, what do you think, assuming we don't get some sort of significant weakness in the economy, what's the likelihood of, say, if the Fed starts cutting again in September, that we have a repeat of what happened last year when they started to cut, where during the span of time, they cut the fed funds rate by 100 basis points, the 10-year yield went up by more than 100 basis points. So that's kind of … I don't want to say it's humorous, but the interesting thing to think about when proponents of cutting talk about the benefit that would accrue to housing and the equity market when in fact those things key off more longer-term yields, not shorter-term yields.

KATHY: Yeah, and that's one of the big things that we keep pointing out is that even if the Fed were to start cutting now, in fact, I think if they were to start cutting now, it would send longer-term yields up because the belief would be that they're stoking potential inflation at a time when, you know, inflation is still above the 2% target. You add in the fiscal policies that will expand the deficit by several trillion dollars over the next 10 years and the global upward pressure in yields. I think Japan's long-term yields hit a new high, multi-decade high. So it's not just the U.S. that has expanding issuance on the horizon, but several other economies do as well. Which is why I say I think it would be a very bad policy move to cut rates right now without some signs the economy really is softening enough to pull inflation from, you know, 2.5% to 3%, where it's kind of been trading, down to that 2% level. It would probably send a very bad message. And you throw in the fact that the dollar's down about 10%, you know, that's probably going to add anywhere from 30 to 40 basis points to inflation because that boosts the price of imported goods along with tariffs. So you throw that all together, and cutting rates now, I agree with the Fed, would be premature.

LIZ ANN: Yeah, you know, I even think that … I've been getting the question a lot lately about the equity market having done so well based on the assumption of imminent cuts by the Fed. I almost think about it in the opposite way. I think part of the reason why the equity market is doing well is because the Fed isn't cutting here, that they don't have the justification for it, or they're not succumbing to political pressure to do so and the fact that you've been essentially just range-bound on the 10-year, which has the most direct impact on the equity market across the yield spectrum. So I don't think that the equity markets lift is a function of anticipating in the near term. I think the equity market may be giving essentially a thumbs up to the Fed being in pause mode.

KATHY: Yeah, I would agree. And you know, we've had this whole focus on the independence of the central banks as well. And the fact that the central bank is pushing back on political pressure is probably a very good thing for the markets, because that is one of the things that, you know, one of the pillars that underpins the markets. And if that weakens, then it leads to higher inflation expectations and worries about monetizing the debt and all kinds of other problems that I think would erode the equity market, certainly confidence in the economy and the equity market. So I agree with you. think just holding steady has apparently been good for equities, right?

LIZ ANN: Yeah, and you know, on the inflation front, I think it's maybe past time that economists or others talk about inflation in the aggregate also do a little bit more deep diving into the innards of the various inflation reports, be it Consumer Price Index or Producer Price Index or the Fed's preferred measure, which is the Personal Consumption Expenditures index. 

Because for all the talk about inflation not having moved much in light of tariffs that have already been put in place, that's at the aggregate level. But in an indicator like the Consumer Price Index, the CPI, what we have going on inside a fairly benign headline reading is crosscurrents. And you've got downward pressure in many of the services categories, including the shelter components and owner's equivalent rent, which (OER for short) is an imputed rent piece and there's been downward pressure there that's offset what actually has been some upward pressure in categories that are most impacted by inflation. If you just look at the category-level changes in the Consumer Price Index, everything from appliances to tools and hardware and building materials, personal computers, recreational goods, recreational vehicles, you're seeing it obviously in, you're starting to see it in autos. 

So to say that there's no inflation based on tariffs, you've got the benefit of these services categories providing some disinflation as an offset to the inflation in areas that are most directly impacted. So I think that's the important thing to do going forward is to segment out the tariff-impacted and not non-tariff-impacted segments of, you know, the wide variety of inflation data that we get.

KATHY: Yeah, I would agree. We're certainly seeing it on the goods side in several things. And frankly, when I look at what the tariff policy is, I'm still somewhat confused as to what we're trying to accomplish here. So if we have a 25%, whatever it is, 35% tariff on Myanmar because we have a trade deficit with Myanmar, what do we expect Myanmar to buy from us? It's not a wealthy country that would tend to buy the things that we produce and export. And we tend to dominate in services rather than in goods. So I wonder how this, what this is all supposed to work out to. Similar with copper, putting a 50% tariff on copper, that's an input to so many of the manufactured goods that we're trying to bring manufacturing home from abroad. But if we make the cost of copper and other metals, steel, aluminum, etc., much more expensive, I guess we can produce all that here, but that will certainly take a long time for production in copper mines in the U.S. to match the output of Chile.

LIZ ANN: Yeah, I mean, we do not have the capacity to just flip a switch and bring domestic production back in terms of copper. If that's the ultimate goal, that's a multi-year phenomenon. That's not an overnight phenomenon. So I agree with you. In fact, I think it's more than 50%, last number I saw was 55% or 56%, of what we import is an input into goods that are produced and ultimately sold here domestically. So I agree. I think there continues to be just a lot of cross currents that make this … and I'll say what I've said many times recently, I think the word "uncertain" is maybe a bit overused these days. Even historically, I would always laugh at the line about "The market hates uncertainty," as if there's ever a certain period of time. 

I think it's … "unstable" is the better descriptor for the backdrop right now. And that's a … there's a different meaning there that I think has come into play in terms of how businesses are thinking about that. And you know, also speaking of which, in terms of businesses and the whole inflation story, I know you look at it, I certainly do, the Institute for Supply Management, the ISM manufacturing and services measures. In addition to just the headline monthly readings on how business is doing in those broad segments of the economy, there are the prices component. And ISM, both services and manufacturing, the prices components lead a measure like Consumer Price Index by two to three months. And those ISM prices measures have kind of shot higher.

So unless we've completely broken the relationship between those two, it's still suggestive of some of the inflation hit that may be ahead of us and that it's maybe premature to write it off as, you know, "nothing to see here," no impact.

KATHY: Yeah, I think sometimes we get impatient. You know, something changes, and we want to see the result right away. You think instantaneous, you know, results from a change in policy or in the markets or whatever. But a lot of this takes a really long time to process and through the economy and through the price indices. And a lot of decisions have to be made along the way. And that just takes a lot of time. And if you jump the gun and react too quickly, you could get caught in the backdraft of some sort of policy change.

Speaking of which, I think we need to talk about the Big, Beautiful Bill.

What's your take on … 

LIZ ANN: Isn't it the "One Big Beautiful Bill"? 

KATHY: Excuse me, the "One Big Beautiful Bill." 

LIZ ANN: OBBB.

KATHY: Yes, so what's your take? Economy? Markets?

LIZ ANN: You know, I think that if you had to list what have been supports for the equity market, clearly it was the incremental news that we got on April 9th of a delay in the reciprocal tariffs, which essentially have had another delay tacked on them as well. But I think on an ongoing basis, the market has done well in part based on the perceived offsets of what the bill brings into the mix in terms of extending the corporate tax cuts as well as some of the expensing provisions, depreciation provisions. So I think that that's been a support. 

On the other hand, I know you do client events as much as I do. I think questions about the deficit and debt are not going to die down in this environment. So there is a heck of a lot more attention on that piece of it. And even if members of the administration or, frankly, many on both sides of the aisle don't tend to have kind of honest and adult conversations about the long-term implications of running huge deficits and the cumulative effect of that, which is a high and rising burden of debt, I think the investor class has always felt deeply concerned about this, and I don't think that changes anytime soon. 

So that's why I think, you know, one of the things we always talk about on this show is what's upcoming in terms of economic data reports. I think the budget balance, which many times doesn't register on people's radars as that's reported, I think that might garner a little bit more attention. What'll be interesting though is whether the average constituent starts to care about it. We've often said that part of the reason why we're in the state that we're in is, even if the investor class cares deeply about it, constituents, even if they care about it broadly in the abstract, they don't tend to vote based on it. So that's, yeah, yet again, TBD.

KATHY: Yeah, I think from my point of view for the bond market, well, by the way, it is the most frequently asked question we get right now is, you know, "Will the government or the U.S. government default on the debt? How is this high and rising debt level going to affect us? Should I not buy Treasuries because I'm worried about a default?" All of that is out there in the mix, and it's very much on the minds of clients, any sort of investor, big, small or otherwise. And my view hasn't changed. The possibility of a default per se is negligible, the likelihood of that happening. I don't think we're going to just say, "No, we're not paying." And I always say we have the capacity to do it. And that's what's frustrating, because we have the capacity to do this.

But we don't have the people willing to make the tough decisions that come with that. Everybody wants to focus either on one side or the other. It's either taxation or it's spending. And clearly, the middle path where you focus on taxation and spending probably is the way you get to a reasonable solution. But that being said, we are in a worsening situation now as a result of this bill.

I think the administration's goal of 3% growth is very unrealistic under the terms of this budget bill. And that is going to make the deficit, the debt-to-GDP, continue to rise if GDP doesn't rise as quickly as it has been or it slows down from here. So it is a concern. I think, though, I try to reassure people that default's not likely, but what we probably will see is continued upward pressure on longer-term rates as investors demand that extra yield to hold anything that isn't short-term debt. And we've heard from the Treasury now the plan is to issue a lot of short-term debt, which is exactly what the Treasury Secretary criticized the previous Treasury Secretary for doing.

But clearly, it's easier to issue a lot of short-term T-bills in an environment like this than longer-term paper. The market will absorb it well. And the hope is that we get our fiscal act together down the road. But it's not looking like there's a great plan in place. And we're not alone. We see rising debt levels around many developed markets.

So I think this means that even if the Fed cuts rates, even if the economy slows down, it's going to be tough to get those long-term rates to come down very much. And that's not going to help the housing market or anything else that's financed off the 10-year. And of course, it probably continues to put some downward pressure on the dollar as well.

LIZ ANN: Yeah, yeah. And speaking of the dollar, we've got second-quarter earnings season about to kick into high gear next week. And it's interesting—analysts did not do any extrapolation of strong first-quarter growth into the remaining three quarters of the year, in part due to the, I'll say it, "instability" of policy.

But interestingly, we have seen a hook higher in positive revisions. But if you look into the details of that, almost all of that is the tech sector. And I think that's where a weaker dollar has actually helped because a weaker dollar, all else equal, benefits S&P earnings because they're more foreign sourced. About 40% of top-line growth for the S&P 500® comes from foreign sources, and a big chunk of that is the tech sector because they have the highest sourcing outside the United States. So when you think about sort of pros and cons of a weaker dollar, if there's one benefit that's accrued from an equity perspective, and part of the reason why I think tech has gotten a lift again, is that the weaker dollar benefits them in terms of those foreign-sourced revenue, leaving the whole tariff piece of it aside.

KATHY: Yeah, it's particularly pronounced the euro on a trade-weighted basis, meaning weighted against all of its trading partners is at a new all-time high. So it's not just up versus the U.S. dollar, but it's up versus a lot of the trading partners. And that's actually going to put some pressure on industrial demand in, say, Germany and other parts of the EU, and I wouldn't be surprised if they push back a little bit. But so far, the fall in the dollar hasn't really translated into a big market experience. I've lived through lots of different currency "experiences" so to say, and this one has been a bit more orderly. It's been quick, but it's been more orderly, I think, partly because the dollar started this move at a pretty high level.

But it is something we have to keep an eye on because if it starts to move really quickly, that stokes inflation. If it becomes disorderly, it becomes very, very difficult for the Fed to cut rates. So it's in the mix, and it's something that I think we really need to keep a close eye on.

LIZ ANN: So it's the look-ahead time to next week. We're recording this midweek. And I think actually today as we're recording it, if I'm correct, we get the minutes from the FOMC out of the latest Fed meeting. So what aside from maybe that is on your radar?

KATHY: Yeah, well, we get some inflation numbers coming up. The CPI that we talked about, Consumer Price Index that we talked about. And that's obviously very important for the markets. And I think between that and the Fed minutes, I will be very curious to see how the conversation was at the Fed about this meeting. It was notable to me that nine of the members did not see more than one rate cut this year. In fact, seven saw none.

So it'll be interesting to see what the kind of rationale was, what the thinking was, what the division was, particularly with all the talk about changes at the head of the Federal Reserve. But then the big inflation numbers coming down the road are going to be the ones that we'll be keeping an eye on. What about you?

LIZ ANN: Well, we get both industrial production and retail sales, and retail sales is essentially the broader component of what goes into recession declarations. So the National Bureau of Economic Research looks at four key coincident indicators: personal income, which has been doing fine; payrolls, which has been … obviously those have been in decent shape; and then industrial production and overall wholesale/retail sales. So it's not exactly the same metric as retail sales, but that sales and industrial production, those two components have been the weaker components. So you've got kind of two of the major indicators that the NBER looks at are hanging in there, and two have weakened. So I think that those two reports are important.

I mentioned earlier import-export prices to get a deeper sense of where there is or isn't inflation pressure tied to tariffs. Claims, we had talked about a little bit of a concern in terms of initial unemployment claims. They rolled back over, which is a good thing in terms of unemployment claims, but that continuing claims number is still hovering around a cycle high. 

And that's suggestive of, frankly, what a lot of other labor market data is suggestive of, which is a low-hiring, low-firing kind of backdrop right now. So continuing claims staying elevated means it's taking people who have lost their job a bit longer to find a job. So they stay on unemployment benefits for a bit longer. And then finally, we get some housing data. We get the building permits and housing starts. But also the National Association of Home Builders—they have an overall housing market index—and that's a builder sentiment index, but it tends to be a pretty decent leading indicator probably for obvious reasons. So that's what's on my radar.

KATHY: Yeah, I think that housing market, you know, has really been in the doldrums for a long, long time. And I'm not in the business of forecasting the housing market, but unless we get lower mortgage rates, I'm not really sure how it's going to bounce back from here.

LIZ ANN: So that's it for us this week. Thanks as always for listening. You can keep up with us in real time on social media. We both post every day practically on X and LinkedIn. I'm @LizAnnSonders on X and LinkedIn. Make sure you're not following one of the many imposters. So make sure you're following the real me.

KATHY: And I'm @KathyJones—that's Kathy with a K—on X and LinkedIn. And you can always read all of our written reports, including charts and graphs, at schwab.com/learn. And of course, if you've enjoyed the show, we'd be really grateful if you'd leave us a review on Apple Podcasts or rating on Spotify or feedback wherever you listen, or tell a friend about the show. We'll talk to you next week.

For important disclosures, see the show notes or visit schwab.com/OnInvesting, where you can also find the transcript.