Key Highlights

• Debate and voting on the “Big Beautiful Bill” to take place this week; passage uncertain.
• Debt ceiling fears show up in T-bill curve; timeline could force separate action on measure.
• Fed on hold, still sees two cuts this year, but short-term inflation expectations are unanchored; we see first cut in September.

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The “Big Beautiful Bill” and the debt limit

EXHIBIT #1: PRONOUNCED KINK IN THE T-BILL CURVE

_{Source: BNY Markets, Bloomberg}

This week is crucial for the Republicans’ “Big Beautiful Bill” as the Senate aims to begin voting on specific provisions in their tax and spending bill this week, with the aim of getting it through the upper chamber by this coming weekend. An ambitious timeline sees the full Congress voting on the bill by the 4th of July holiday. As we have been pointing out, the budget bill includes language allowing the debt ceiling to be raised by $5tn, a full trillion dollars more than a similar provision in the House’s version of the legislation. When each chamber’s version of the bill is passed, a compromise negotiation will take place between the Senate and the House, and we’ll have an idea of the final size of the debt increase.

However, markets are beginning to register some concern about the timing and passage of the debt ceiling provision. T-bills on August 19, probably right in the “sweet spot” of potential X-date ranges, have cheapened significantly compared to the rest of the curve, indicating a reluctance to hold paper that falls due during this – and any neighboring – date. Exhibit #1 captures this pronounced “kink” in the bills curve. Note that bills due on surrounding dates also readily exhibit relative cheapness, indicating growing risk of a debt ceiling crisis.

After positive corporate tax collections, the Treasury General Account (TGA) currently amounts to $383bn, and “extraordinary measures” by the Treasury Department to conserve cash and spend out of existing monies elsewhere in the government provide an additional $89bn (see Exhibit #2). But with tax revenues and spending hard to predict, estimates of the X-date vary. Most credible observers have estimates ranging from late July to September, but the market has started to focus on the mid-August period as its bet on when the money will run out. 

EXHIBIT #2: HOW MUCH MONEY IS LEFT?

_{Source: BNY Markets, U.S. Department of the Treasury}

If the comprehensive tax and spending bill is not passed by late July, there is a danger the X-date will occur before the debt ceiling can be raised. Congress goes on summer recess at the end of July. This means that if we were to get close to the end of the month and the bill remains unpassed, the debt ceiling provision would have to be lifted out of the main bill and voted on separately. This opens the door for some very fraught political machinations as it’s likely some Democratic support for the increase will be needed, setting up negotiations that are likely to be protracted and difficult. 

Fed stays on hold, keeps two cuts for the year

Last Wednesday’s FOMC meeting expectedly resulted in no monetary policy change from the central bank, and a new set of dots that indicated the Fed still intends to cut rates twice this year, a bit of a dovish surprise. We were among the many observers who thought the median “dot” from the Summary of Economic Projections would show one less cut than had been indicated in the previous two SEPs, in March 2025 and December 2024.

While the dot plot for rate cuts was left unchanged, the Fed’s projections for growth (nudged lower) and inflation (higher) indicated a stagflationary outlook for the next two years, and Chair Powell clearly argued that “increases in tariffs this year are likely to push up prices and weigh on economic activity.” The dots reflect this outlook, with the projected GDP for 2025 at just 1.4% (down from 1.7%) and core PCE inflation at 3.1% (up from 2.8%). Moreover, the balance of risks for the economy showed that participants viewed risks to growth as skewed to the downside and those for inflation skewed to the upside.

The Fed, particularly Chair Powell, has maintained that uncertainty requires patience, and its main concern is keeping inflation expectations under control. From Powell’s press conference: “Our obligation is to keep longer-term inflation expectations well anchored and to prevent a one-time increase in the price level from becoming an ongoing inflation problem.” Note the emphasis on long-term inflation expectations, which have indeed remained steady, despite increases in short-term inflation fears. Central bank orthodoxy centers on these longer-run projections being steady with less emphasis on shorter-run expectations. We wrote about this last week in our FOMC preview (see here).

However, new research suggests that not only do shorter-run inflation expectations matter more than expected for monetary policy and inflation outcomes, but they also look to be unanchored at present. Exhibit #3 shows short- and long-run inflation expectations from two survey measures – the University of Michigan Consumer Survey and the New York Fed’s Survey of Consumer Expectations. Note that there is a difference, particularly in the Michigan data, between short- and long-run forecasts for prices. This “inverted term structure” for inflation expectations indicates the effect of tariffs driving inflation expectations.

EXHIBIT #3: UNANCHORED SHORT-TERM INFLATION EXPECTATIONS

_{Source: BNY Markets, University of Michigan Consumer Survey, Federal Reserve Bank of New York}

Bottom line

We still expect the Fed to make two cuts, with the first one occurring in September, and the second one most likely in December. We think the economic demand data – employment, consumption, investment, etc. – will weaken sufficiently by then to allow the Fed to adjust monetary policy. Powell made the interesting assertion – and not for the first time – that the central bank’s two objectives (stable prices and maximum employment) could come into “tension.” He added that “if that were to occur, we would consider how far the economy is from each goal, and the potentially different time horizons over which those respective gaps would be anticipated to close.” While this represents clear thinking and likely sound monetary policy, the message is hardly precise. This sets up a summer of uncertainty in monetary policy, matching uncertainty across numerous political and economic factors. 

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