"Big Beautiful Bill": Impact on the US economy and the dollar

A government spending and tax cut bill is a proposed legislation that combines provisions for government expenditures with measures to reduce taxes. Such a bill aims to influence the economy by increasing or decreasing the money flow within it. Typically, the spending components allocate funds to various government programs, services, or infrastructure projects, while the tax cut components reduce the amount of taxes individuals or corporations owe.

These bills are often used as fiscal policy tools to stimulate economic growth, provide relief to taxpayers, or fund specific government initiatives.

While a full list would be extensive, here are a few prominent historical examples of government spending and tax cut bills in the United States, illustrating different economic contexts and goals:

• Economic Recovery Tax Act of 1981 (ERTA): Enacted under President Ronald Reagan, this act implemented substantial cuts to individual income taxes, corporate taxes, and capital gains taxes. It was a cornerstone of "Reaganomics," aimed at stimulating the economy through supply-side incentives and reduced government intervention. While it led to economic growth, it also contributed to rising budget deficits.
• American Recovery and Reinvestment Act of 2009 (ARRA): Passed during the Great Recession, this was a large-scale stimulus package that included a significant amount of government spending on infrastructure, education, health care, and energy, as well as tax cuts and unemployment benefits. Its primary goal was to mitigate the economic downturn and create jobs.
• Tax Cuts and Jobs Act of 2017: Enacted under President Donald Trump, this legislation made broad changes to the US tax code, most notably reducing the corporate income tax rate from 35% to 21% and also lowering individual income tax rates, though with a more complex structure. The stated goals were to boost economic growth and make the US more competitive.
• The American Rescue Plan 2021: A legislation that was passed under the Biden administration. This comprehensive stimulus package featured an expanded child tax credit and significant government spending on areas like infrastructure, education, health care, and energy, alongside tax cuts and unemployment benefits. Its main objective was to counter the economic downturn and foster job creation in the wake of the COVID-19 pandemic.
  The act, in conjunction with infrastructure investments and other fiscal policies, played a key role in boosting GDP growth and contributing to substantial job creation during the Biden administration's term, driven by the post-COVID economic rebound. President Biden signed the bill into law on March 11th, 2021. The bill allocated billions of dollars for unemployment benefits, support for small businesses, and direct stimulus checks.
• The Budget Reconciliation Bill 2025 (The Big Beautiful Bill): The "Big Beautiful Bill" aims to influence the US economy by implementing tax cuts and adjusting spending. Specifically, it focuses on extending the 2017 income tax cuts and increasing the SALT cap, which are intended to provide financial relief primarily to wealthy Americans. While these tax cuts are designed to stimulate economic activity by encouraging investment and consumption, the bill also proposes cuts to healthcare programs like Medicaid and SNAP benefits. These reductions are intended to offset some of the revenue lost from the tax cuts. Additionally, the bill addresses other areas, such as clean energy, mass deportations, student loans, and military spending. The overall impact on the economy would depend on how these various components interact, with the tax cuts aiming to boost growth by incentivizing investment and consumption, and the spending adjustments redirecting resources.
  The House Budget Committee signed off on this bill, causing the 30-year Treasury yield to top 5%. This bill is expected to add at least $3.3 trillion to the national debt over the next decade. The Committee for a Responsible Federal Budget estimates this bill could increase the primary budget deficit by approximately $450 billion in FY2026 and almost $600 billion in FY2027. Higher deficits can generally lead to higher long-term interest rates, which could negatively impact the US economy.

When discussing the impact of tax cuts on the US economy, it's crucial to have a multifaceted perspective, acknowledging both potential benefits and drawbacks. Government spending and tax bills, as fiscal policy tools, significantly impact the economy in several ways:

• Increased spending: Government spending directly adds to aggregate demand. When the government buys goods and services, invests in infrastructure, or provides transfer payments, it increases economic activity, leading to higher production and employment.
• Tax cuts: Tax cuts increase the disposable income of individuals and businesses. This can lead to increased consumption by households and increased investment by companies, thereby boosting aggregate demand.

• Stimulation: Both increased spending and tax cuts can stimulate economic growth, especially during recessions. By injecting money into the economy, they can encourage spending, investment, and job creation.
• Supply-side effects: Some tax cuts (e.g., on corporate profits or capital gains) are intended to incentivize investment and production, potentially leading to long-term supply-side growth.

• Increased demand: If the government prints more money to service the debt, it can lead to inflation, which erodes the currency's purchasing power and causes depreciation. If the economy is already operating near full capacity, a significant increase in government spending or tax cuts can lead to demand-pull inflation, as too much money chases too few goods.

• Deficits: When government spending exceeds tax revenues, it creates a budget deficit. Persistent deficits financed by borrowing contribute to the national debt. A rising national debt can lead to higher interest rates, potential crowding out of private investment, and intergenerational burdens. Tax cuts, especially those not fully offset by spending cuts, can lead to a significant increase in the national debt and budget deficit. This can negatively impact the US dollar.

• Targeted spending: Government spending on social programs, education, or healthcare can aim to reduce income inequality.
• Tax structure: The structure of tax cuts (e.g., favoring specific income brackets or industries) can also impact income distribution.

• Federal Reserve response: If tax cuts lead to higher inflation or strong economic growth, the Federal Reserve might be prompted to raise interest rates to cool down the economy. Higher interest rates typically attract foreign investment seeking better returns, increasing demand for the US dollar and causing it to appreciate.
• Impact on Treasury Yields: As mentioned, tax cuts contributing to higher deficits can push up term premiums for longer-term US Treasury notes and bonds, leading to higher yields. The 30-year Treasury yield topped 5% due to a budget reconciliation bill.

• Uncertainty and volatility: Large-scale tax reforms and their associated fiscal implications can create uncertainty in the markets, leading to volatility in the exchange rate. The "erratic approach to implementing global trade tariffs by the Trump administration reinforces stagflation risk for the US economy, which could further push up term premiums for longer-term US Treasury notes and bonds," impacting sentiment.
• "Sell America" theme: Negative market sentiment, such as the "Sell America" theme, can cause significant sell-offs in the US dollar.

Government borrowing to fund spending or tax cuts can increase demand for credit, raising interest rates and potentially "crowding out" private investment. Higher deficits generally lead to higher long-term interest rates, which, despite initially attracting foreign investment, can signal economic instability and lead to a sell-off. For example, the budget reconciliation bill that included rolling over 2017 tax cuts and increasing the SALT cap caused the 30-year Treasury yield to exceed 5%.

If tax cuts result in higher inflation or strong economic growth, the Federal Reserve might raise interest rates to cool the economy. These higher rates typically attract foreign investment, increasing demand for the US dollar and causing it to appreciate. Tax cuts contributing to higher deficits can also increase term premiums for longer-term US Treasury notes and bonds, leading to higher yields.

Increased economic activity and potentially higher interest rates from government spending or tax cuts can attract foreign capital, strengthening the domestic currency. Ultimately, government spending and tax bills are powerful tools for macroeconomic objectives, but their effects depend on the economic context and specific legislation.

Having examined historical government spending and tax cut bills, we now understand their potential economic impact. We will next explore the effect of these bills on the US dollar exchange rate and the fluctuations in its value against other currencies.

The above chart for the US Dollar Index (DXY) highlights how the US dollar reacted following the implementation of a bill. The US dollar exchange rate rose against other currencies, as represented by the DXY index; in almost all cases, it rose by different percentage points for each bill, depending on economic conditions and the details of each bill

Even though in some cases, such as in the American Recovery and Reinvestment Act of 2009, the US dollar initially dropped, potentially due to the near-zero interest rates environment at the time, the DXY was able to reverse course in the years that followed.

The question for currency traders here is how much of an impact the “Big, Beautiful Bill” will have on the US dollar exchange rate against other currencies. Government spending can lead to faster growth, higher inflation, and higher interest rates. This comes at the same time the Trump administration continues to negotiate tariffs with the US largest trade partners, specifically Canada, Mexico, the European Union, China, and Japan, thus potentially having a direct impact on the exchange rates for currency pairs such as USD/CAD, USD/MXN, EUR/USD, USD/CNH, and USD/JPY.

With all that said, markets can sometimes behave differently for other reasons, such as the complex nature of the factors impacting exchange rates.

Currency exchange rates are constantly fluctuating, driven by a complex interplay of various economic, political, and psychological factors. Here are the main ones:

• Interest rates,
• Inflation rates,
• Economic performance and growth (GDP, unemployment, etc.),
• Trade balances (current account deficits/surpluses),
• Political stability and events,
• Market sentiment and speculation,
• Public debt,
• Terms of trade.

These factors are interconnected and constantly influencing each other, making currency exchange rate movements complex and unpredictable.

In December 2024, Federal Reserve officials and bond traders (according to CME data) anticipated a full 1% interest rate cut in 2025, comprising four 25-basis-point cuts at the scheduled FOMC meetings. This was based on inflation continuing to decline and was forecasted to continue on the same path. However, as the new US administration took office and began to implement its new fiscal policy approaches in the form of tax cuts and tariffs, FED officials and markets have aggressively reduced their interest rate cut expectations as they became concerned about rising inflation expectations, leading to the higher interest rate as a result of the new fiscal policy approach.

Currently, as we have just ended the second quarter of 2025, markets and Fed officials remain divided on the policy impact on interest rates. However, the FOMC and the bond market participants have reduced their interest rate cut expectations by half and are looking at only 2 x 25 bps cuts in 2025. The Fed chair, Jerome Powell, has reiterated multiple times that the US economy remains in good shape and the job market remains strong, which allowed the FED to be in a good position for a wait-and-see approach.

In summary, while tax cuts are often intended to boost economic growth, their impact on the US dollar exchange rate is complex. It can be influenced by how they affect the national debt, inflation expectations, interest rates, and overall market sentiment. Significant tax cuts, particularly when unfunded, can lead to increased deficits, concerns about fiscal stability, and, ultimately, a weakening of the US dollar.

Government spending and tax cut bills, such as the "Big Beautiful Bill," serve as crucial fiscal policy tools aimed at influencing the economy through various mechanisms. While they can stimulate economic growth by boosting aggregate demand, encouraging investment, and creating jobs, their broader impact is complex and multifaceted. The "Big Beautiful Bill," with its combination of extended tax cuts and spending adjustments, exemplifies how such legislation seeks to achieve macroeconomic objectives. However, the potential for increased national debt, effects on interest rates, and the nuanced interplay of these factors highlight the intricate balance policymakers must strike to ensure sustainable economic health and stability.