All eyes on DC: 3 things investors should watch

1. The deficit

The Congressional Budget Office (CBO) analyzed the budgetary and economic effects of the “One Big Beautiful Bill” passed by the House.

The bottom line: The CBO estimates that over the next 10 years, the cost of the bill is estimated to be $2.4 trillion. While a large number, the estimate is less than a preliminary CBO estimate of $3.8 trillion. What’s more, a separate CBO analysis found that tariffs would cut the deficit by $2.8 trillion. On net, the two policies are estimated to shrink the primary deficit by ~$400 billion over 10 years.

Important: This analysis is on the primary deficit and does not include interest cost. So even with the offsetting tariff revenue on the proposed budget costs, deficits after interest costs would continue to increase in all likelihood.

First, this analysis remains in flux, given the executive orders imposing the tariffs (which provide a large part of the $2.8 trillion offset) remain in place pending consideration by the Federal Circuit Court of Appeals. Second, the bill still needs to be passed through the Senate and is subject to changes that would modify these estimates.

With those disclaimers out of the way, all things considered, this is an improvement of the deficit estimate relative to the previous CBO estimate. But we don’t think this changes the trajectory of the U.S. fiscal position, and we would expect the budget deficit to continue to increase over time when considering interest costs. This means term premium and volatility are expected to persist, especially at the longer end of the curve. In fixed income, we prefer the belly of the curve and in, which is more highly correlated with moves from the Fed relative to the long end. For U.S. taxable investors, our preferred fixed income instrument remains municipal bonds. Ten-year municipal bonds spread, or compensation above inflation expectations, is at one of the highest levels in a decade and a half. What’s more, the income is tax-advantaged.

2. Section 899

Up until late last week, most of us probably hadn’t heard of Section 899, given it’s buried in the details of the One Big Beautiful Bill. But now it’s making headlines and raising questions, especially from those outside the United States. Why? If passed, it could deter foreign investment in the United States, reduce demand for U.S. assets and pressure the dollar. Here’s what you need to know about the provision, based on our read of the sparse details. But remember: It’s still just a proposal and could change, be clarified or even be scrapped before becoming law.

What it is: It’s shorthand for a “retaliatory” U.S. tax measure on companies and investors from countries deemed to have “unfair foreign taxes.”

Who it targets: Individuals, corporations and governments linked to “discriminatory foreign countries” would be considered “applicable persons.” The main targets appear to be countries taxing U.S. corporations, particularly those with digital services taxes (DSTs) and undertaxed profits rules (UTPRs), such as France, Germany and the United Kingdom. Countries on the “naughty list” that impose such taxes, and thus are subject to Section 899, would be reported quarterly.

What’s in scope: The most significant item for investors and markets is likely around withholding tax on passive U.S.-sourced income, such as dividends, interest and royalties earned from U.S. investments by foreign investors.

As it currently appears, interest on U.S. government and corporate bonds and deposits is expected to remain exempt under the U.S. portfolio interest exemption, which permits non-U.S. investors to receive interest from specific U.S. debt instruments without withholding tax. Non-real-estate-related capital gains should also continue to be considered foreign sourced and thus not taxable. U.S. dividend and preferred income are the most likely items to fall within the tax scope.

Tax rates for affected parties would increase gradually based on a country’s classification as discriminatory, starting at a 5% increase and adding another 5% each year the country maintains an unfair tax policy, capped at a maximum of 20% above the statutory tax rate for the relevant income item.

Treasury Secretary Scott Bessent has been a prominent advocate for deregulation, emphasizing its importance to unlock non-government lending and stimulate private sector growth. This shift presents investment opportunities in U.S. financial equities and preferreds, given potential changes in bank balance sheets and profitability.

We see deregulation’s effect across four aspects in the banking sector:

Buybacks:

• Excess capital is used for stock buybacks, which can benefit equities.
• Notably, equity buybacks may pose risks for preferreds if funded by increased preferred issuance.

Loan growth:

• Loan growth drives net interest income and earnings, significantly influencing stock prices.
• Deregulation may lower loan costs, potentially boosting private sector growth.

Supplementary Leverage Ratio (SLR) reform:

• SLR reforms aim to improve liquidity in the Treasury market.
• Excluding Treasuries from assets in the SLR calculation could increase Tier 1 capital surpluses, allowing banks to hold fewer preferreds.
• This adjustment could enhance banks’ ability to buy Treasuries and facilitate market-making trades, improving overall market liquidity.

Profitability:

• Profitability may rise through reduced expenses and increased capital markets activity.
• Regulatory consolidation could lower operating costs and boost deal activity, enhancing fee revenue and earnings per share (EPS).

Overall, bank deregulation offers opportunities for enhanced shareholder returns, loan growth and M&A activity, with improved profitability through increased capital markets activity and reduced regulatory expenses. Preferreds and equities are both likely to benefit from these changes.

Curious about how the things we are watching can affect your portfolio? Reach out to your J.P. Morgan team.