Senators are likely to strip cost savings from GOP reconciliation bill

Moody's downgrade of U.S. credit on Friday helped put into focus the U.S. government's ballooning budget deficit and President Donald Trump's hopes to add trillions more to the national debt.

The downgrade landed as House Republicans push a tax and spending bill that could significantly worsen the country's fiscal outlook, and analysts warn that the legislation could become even more expensive once the U.S. Senate gets its hands on it.

That means more borrowing, more pressure on Treasury bond yields and potentially higher rates on everything from mortgages to car loans.

There isn't the same appetite in the Senate for politically difficult cuts to Medicaid and reductions in clean-energy tax credits that benefit many business ventures in states represented by Republicans, according to Henrietta Treyz, director of economic policy at Veda Partners.

The lack of appetite for sharp reductions in spending in the Senate is one reason the House may fail to advance the tax bill by Speaker Mike Johnson's self-imposed Friday deadline.

"House members are being asked to walk the plank politically for a bill that senators from their own party are are telegraphing clearly will not pass in their chamber once it gets to them," Treyz wrote in a weekend note to clients.

House leadership plans to bring up the bill in the Rules Committee this week, where changes will be proposed, and they hope to bring it to a vote in the full House before the Memorial Day holiday.

If the measure passes the House, the Senate would then begin to consider it.

Debt warning lights flash

Yields on U.S. government debt have remained stubbornly high since Trump took office on promises to lower consumer prices and the cost of living.

Yields for U.S. government bonds BX:TMUBMUSD10Y ticked higher Monday, with some analysts pointing to depressed foreign demand for U.S. assets amid policy uncertainty.

Thierry Wizman, strategist at Macquarie, said in a Monday note that the bond-market reaction is related to "political and institutional breakdown" within the U.S. government, which has become unable to "course correct" and address blatantly unsustainable budget deficits.

"Fiscal hawks can only hope that because of the Moody's downgrade, and because long-term yields are rising again, ultra-conservatives in the House will be successful in getting deeper cuts to government spending," he wrote.

The stakes could be high for consumers too, as tariff costs and stubbornly high interest rates weigh on their purchasing power.

David Kelly, chief global strategist at J.P. Morgan Asset Management, wrote in a Monday note that the tax bill and tariffs will prevent the Federal Reserve from lowering interest rates.

"Long-term interest rates may well drift up due to the rising borrowing needs of the federal government and the psychological impact on markets of further evidence that Washington has no intention of tackling the nation's worsening debt problem," he wrote.

Noises coming out of the Senate are unlikely to leave markets with more confidence that the upper chamber sees deficit reduction as a priority.

Medicaid mayhem

One of the biggest sources of savings in the House bill is steep cuts to Medicaid, which the Congressional Budget Office predicts could save the federal government $715 billion but result in 8.6 million fewer Americans having health insurance by 2034.

That would be the largest rollback in the history of the program, which covers 78 million Americans, and many Republicans are wary of voting for legislation that restricts Medicaid enrollment and uses that savings for tax cuts that will mostly benefit the wealthy.

Republican Sen. Josh Hawley of Missouri articulated those fears in a recent New York Times editorial, in which he argued forcefully against reducing Medicaid spending.

Some Republicans want to "build our big, beautiful bill around slashing health insurance for the working poor," Hawley wrote. "But that argument is both morally wrong and politically suicidal."

Analysts at Beacon Policy Advisors said in a Monday note that Hawley isn't the only one in the Senate who will be reluctant to vote for significant Medicaid cuts.

"GOP senators are warning some big changes could be in store," they wrote.

The House version of the bill reportedly will include even more aggressive Medicaid cuts, after conservative hardliners temporarily blocked the legislation in the budget committee Friday before allowing it to advance Sunday night.

Republican Rep. Chip Roy of Texas said Sunday that he withdrew his immediate opposition to the bill advancing because it will now accelerate new work requirements for Medicaid and cut energy-production subsidies more aggressively.

Despite that, he argued that the bill still "doesn't meet the moment" because it doesn't cut spending enough.

The SALT problem

Meanwhile, moderate Republicans in the House are demanding an expensive partial restoration of deductibility of state and local taxes from federal returns.

Republicans placed a $10,000 cap on those deductions to help pay for Trump's 2017 tax cuts on corporations and individuals, to the dismay of GOP representatives from high-tax states, including New York and California.

The House version of the bill lifts the cap from $10,000 to $30,000 for joint filers making less than $400,000, but some Republicans say that cap is still too low, and they likely have the votes to sink the bill entirely if it isn't raised further.

Have bond markets finally had enough?

U.S. politicians have long been criticized for spending money wastefully and avoiding difficult decisions that might cost them re-election. But today's crop are historical outliers.

The federal budget deficit was $1.8 trillion in 2024, and the Congressional Budget Office estimates it will come in at $1.9 trillion in 2025, or more than 6% of gross domestic product, a figure rarely seen of outside wartime or other crisis.

Economists say a sustainable deficit is one that matches an economy's growth rate, which has historically averaged between 2% and 3%.

That's why many observers are arguing that the U.S. shouldn't even be considering extending the 2017 tax cuts, let alone adding new ones like tax breaks for overtime pay and car-loan interest.

Ethan Harris, the former chief economist for Bank of America, argued in a Monday essay that if the U.S. weren't at the center of the global financial system, and if U.S. Treasury debt were not the legacy "risk-free" asset dominating global markets, behavior like what's being seen in Washington today would have already created a situation where Congress would be forced to cut the deficit to quell a bond-market revolt.

"In the long run, some kind of funding crisis seems almost inevitable," Harris said, "because that seems to be the only thing that will wake up Washington."