Macro & Strategy - August 2025

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Beautiful Dangerous

Section 1: What’s so beautiful about that one big bill?

In Washington, beauty is often in the eye of the beholder—or, more precisely, in the eye of the beneficiary. The latest fiscal package, dubbed the One Big Beautiful Bill (OBBB), is a sprawling mix of tax cuts, spending shifts, and political signalling. It’s also a fiscal Rorschach test: To some, it’s a progrowth catalyst, to others, a reckless gamble with America’s fiscal future.

At its core, the bill extends Trump’s 2017 tax cuts, originally set to expire in 2026. These include reductions for individuals and businesses, with new sweeteners, such as tax relief on tips and overtime. For corporations, the bill revives full expensing for R&D and factory construction—moves aimed squarely at boosting capital expenditures and reshoring supply chains.

But tax cuts don’t come free. To partially offset the revenue loss, the bill trims spending on Medicaid, restarts student loan payments, and rolls back some Biden-era green energy incentives. Defence and border security, however, get a budgetary boost—an unmistakable nod to the Republican base. The budget for border security is now in line with the annual military budgets of the United Kingdom and Japan.

The Congressional Budget Office estimates the bill will add $3.2 trillion to the deficit over the next 10 years, assuming the 2017 tax cuts would have otherwise expired. That’s a big assumption, but a necessary one: Congress has a habit of making temporary tax cuts permanent, and one can only assume that the bill’s cost-control portions scheduled for 2029 and beyond could well be cancelled by then.

Highlights

• The U.S. fiscal trajectory is increasingly unsustainable, with structurally high deficits and rising interest burdens threatening long-term stability.
• The U.S. Treasury curve reflects growing investor anxiety, as rising term premia and diminished safehaven demand push long-term yields higher.
• We have closed all discretionary FX positions and maintain a risk-on stance with an overweight on equities, while adding a position on gold and staying underweight long-duration fixed income.

Tariffs are the bill’s wildcard. Although the exact rates and trade responses remain uncertain, preliminary estimates suggest that additional tariff revenues from Trump’s various executive orders could reach $250–300 billion annually¹ . That’s not pocket change, but it’s not enough to fully offset the bill’s cost, especially when the drag that tariffs impose on growth is factored in.

Distributionally, the bill is regressive. The tax relief skews toward higher-income households and businesses, while the spending cuts disproportionately affect lower-income Americans. Programs such as Medicaid bear the brunt, although many of these cuts are delayed until after Trump’s second term, making them more political bargaining chips than fiscal certainties.

From a macro perspective, what matters is the evolving picture of the deficit. A year-on-year analysis of the tax and spending provision gives us an idea of the expected impact on economic growth. The bill’s fiscal impulse will be positive in the early years, particularly in 2026, offering a short-term growth boost. That is a big difference from the status quo, because the expiration of the 2017 tax cuts would have created a significant drag.

The timing is no accident. The fiscal impulse kicks in just as the 2026 midterms approach, potentially lending a helping hand to Republican candidates. It will also offset some of the negative impacts of tariffs. But, by 2029, the stimulus fades and the fiscal impulse becomes negative, assuming no further policy changes.

That will, however, be for another administration to deal with, and, as discussed above, the costcontrol measures that are supposed to kick in then may very well be cancelled.

The bigger picture? This bill locks in structurally high deficits, even in peacetime and with a growing economy. Even when the tariff revenues are included, the deficit is expected to remain at about 6% of GDP, a level that was reached only once between World War II and the Covid-19 pandemic: in 2009, in the depths of the Great Financial Crisis.

This puzzle will not be easy to solve. Interest payments now account for roughly half the total deficit. To reduce the debt burden, the U.S. would need sustained primary surpluses—an unlikely scenario in today’s political climate. For investors, this raises some uncomfortable questions. Have U.S. equities been riding a wave of fiscal profligacy? And, if so, what happens when the tide turns?

Section 2: A holistic view of the U.S. fiscal situation

Debt: It’s not the size but the trajectory

When does debt become dangerous? It’s not a question of absolute levels but of trajectory. A debt-to-GDP ratio of 100% can be sustainable if it’s stable or falling. But a ratio of 50% that’s rising relentlessly? That’s a red flag.

Economists often invoke the intertemporal budget constraint: The present value of future primary surpluses must equal the current debt stock. If that condition fails, debt must eventually be inflated away, defaulted on, or offset by drastic policy shifts.

For emerging markets, the tipping point often comes early. But, for developed economies, especially the U.S., issuer of the world’s reserve currency, the bar is higher. Deep capital markets, monetary sovereignty, and institutional credibility buy time. But not immunity.

But let’s be clear: The real, imminent risk for the U.S. isn’t default—it’s repricing. If bond markets lose faith in U.S. fiscal sustainability, they’ll demand a higher risk premium. That means higher rates, lower asset valuations, and tighter financial conditions.

The fiscal gap: the $200-trillion elephant in the room

Economist Laurence Kotlikoff’s work on the fiscal gap concept² is sobering. The fiscal gap measures the present-value shortfall between a government’s projected revenues and its projected spending obligations—essentially, the size of the adjustment needed today to make fiscal policy sustainable over the long run.

Kotlikoff estimates the U.S. faces a $150–200 trillion shortfall over the very long term. According to his recent work, closing the gap would require a 40-60% permanent increase in federal taxes, or equivalent spending cuts of 30-40%. Politically implausible? Absolutely. But the point stands: Current policies are unsustainable.

This isn’t just a theoretical exercise. The fiscal gap reflects the mismatch between long-term spending commitments and the current revenue structure. It’s the structural deficit, not the cyclical one, that keeps economists up at night.

Thresholds that matter

This conversation begs the question: Which measure of government indebtedness is actually the most useful for a country such as the U.S.? And what thresholds should we watch?

The literature offers a few candidates:

1. Debt/GDP above 90%: Reinhart and Rogoff’s 2010 paper³ suggested this level could impair growth. The finding has been debated, but the intuition remains: High debt can crowd out investment and reduce fiscal flexibility. Even though the threshold might be higher for an economy like that of the U.S., academic studies⁴ suggest that a one-percentage-point increase in the debt-to-GDP ratio raises the U.S. 10-year rate by three basis points. As the CBO forecasts this ratio to increase by roughly 20 percentage points over the coming decade, this would mean a permanent increase of 60 basis points on the 10-year rate.
2. Persistent primary deficits during expansions: If a government can’t run surpluses in good times, it has no buffer for bad times.
3. Interest payments exceeding 15–20% of revenue: This is where things get uncomfortable.

The ratio of interest payments to revenue seems to be generally favoured and provides the most useful historical comparisons. On that point, the U.S. is flashing red. According to the World Bank, interest payments hit 18% of federal revenue in 2023.

That’s historically high—and rising. The World Bank considers 15–20% a stress zone. For emerging markets, it’s a crisis trigger. For the U.S., it’s a warning shot. As a matter of comparison, the U.S. had the same ratio in 2023 as Greece did in 2011 at the dawn of the European sovereign debt crisis.

Does that mean that the U.S. economy is on the brink of a fiscal accident? Of course not. But it does illustrate that the risks have become imminent, and that the time to act, realistically, is now.

Why interest costs matter more than ever

Why does this the U.S. fiscal situation matter so much, now? There are multiple real-world reasons, beyond the financial-market risks.

Among other reasons, an excessive debt burden for a country has effects on these important dimensions:

• Crowding out: More interest paid means less room for infrastructure, defence, or social programs.
• Market confidence: Rising debt service costs can spook investors.
• Policy rigidity: High interest burdens limit fiscal flexibility in downturns.

If you’re still not convinced, consider that the Committee for a Responsible Federal Budget notes that interest is already the fifth-largest federal expenditure. By 2045, it could eclipse all discretionary spending. The CBO projects interest costs could reach 8.7% of GDP by 2051, up from a historical average of 2%. That’s not just unsustainable—it’s destabilizing.

The R > G Problem

Seen through the lens of macroeconomic theory, the upward pressure on interest rates combined with lower prospects for economic growth is, you guessed it, concerning.

For much of the 2010s, interest rates (R) were below GDP growth (G), giving most global governments room to run a small primary deficit (namely the deficit before interest payments) while keeping debt levels under control. Of course, the U.S. government has gone beyond this margin of safety by running primary deficits beyond 3% for most of the decade, causing its debt to balloon.

The post-pandemic world has flipped the script. Now, as longer-term rates (see the 10-year rate in the chart below) are rising to multidecade highs, R could grow beyond G, meaning the picture could change drastically.

The current picture shows that the U.S. government pays 3.3% interest on its outstanding debt and the economy grows at 4.7%. Thus, the U.S. government could run a primary deficit of 1.4% of GDP and still keep debt stable at 100% of GDP. Instead, the U.S. is running a primary deficit of more than 3%, more than twice that level. And looking forward, given higher 10-year rates already more or less matching the pace of nominal growth, we can see that the room for primary deficits is simply disappearing.

We could go on and on, but the message is load and clear: The math doesn't work.

Section 3: Lessons form Canada; been there, done that

If the U.S. is looking for a fiscal role model, it need look no further than its northern neighbour. In the early 1990s, Canada faced a debt crisis of its own. Interest payments consumed 30% of federal revenue. The response? Swift, sweeping reform.

The Canadian government adopted a 6-to-1 ratio of spending cuts to tax hikes. Program spending fell nearly 10% in nominal terms, and 14% in real terms, between 1994 and 1997. Some ministries saw budget cuts of 50% or more. Transfers to provinces were slashed. Corporate subsidies were gutted. Privatization accelerated. And fiscal anchors were introduced to restore credibility. Conservative revenue forecasts and contingency reserves became standard practice. The result? Canada went from fiscal pariah to poster child.

The debt-to-GDP ratio fell. Interest burdens eased. And market confidence returned. In terms of real economic growth, the Canadian economy lagged the U.S. for most of the 1990s, before getting back to a similar trend in the following decade, even with some bouts of outperformance.

The lesson: Fiscal turnarounds are possible, but they require political will, institutional discipline, and a willingness to make tough choices.

Section 4: Prescriptions for the U.S.; the road back to sanity

The U.S. has the capacity to fix its fiscal house. Taxes are low by international standards. Productivity growth remains solid. The current fiscal issues are more theoretical in nature than anything else. But time is running short.

The IMF, in its 2024 Article IV statement, was blunt: The U.S. deficit is “too large,” and debt is on an unsustainable path. It recommends a front-loaded consolidation of 1% of GDP a year, with the aim of a primary surplus by the early 2030s.

That won’t be easy. The U.S. hasn’t run a primary surplus since 2001. And with real interest rates now exceeding real GDP growth, the math is unforgiving.

So what’s to be done? The Trump administration has shown a certain willingness to tackle this problem with its broad tariff policy, in essence a substantial tax hike on the U.S. consumer. We are, however, skeptical about the ability of tariffs to generate a reliable stream of revenue. The stated goals of the policy are often at odds with one another⁵ , while their legality remains dubious.

Nevertheless, some amount of tariff revenue is likely to last beyond the Trump administration and be part of the solution. But, as discussed in the first section, even under somewhat generous assumptions, such revenue will fall well short of solving the fiscal puzzle. As a result, we think a combination of the following list is in the cards for the American people.

1. Restore fiscal discipline
   • Adopt credible fiscal anchors.
   • Reform entitlement programs to reflect demographic realities.
   • Cap discretionary spending and conduct regular reviews.
2. Improve revenue efficiency
   • Broaden the tax base by reducing loopholes.
   • Modernize IRS systems to close the tax gap, namely taxes owed but not paid on time. According to recent estimates, the IRS fails to collect $700 billion in taxes owed to the government.
   • Consider introducing taxes on consumption or a value-added tax (VAT).
3. Reduce the interest burden
   • Lengthen debt maturities to lock in lower rates.
   • Avoid over-reliance on short-term debt.
   • Preserve the Federal Reserve’s independence to maintain monetary credibility.
4. Rebuild market confidence
   • End fiscal brinkmanship—debt ceiling standoffs erode trust.
   • Give more weight to the CBO’s long-term projections and stress tests.
   • Signal bipartisan commitment, perhaps via a fiscal commission.

The key question as of mid-2025 is: What will it take for this administration, or the next, to get serious about sorting out the fiscal situation?

The obvious answer is that a market scare with failing government auctions could force the issue. Or an adverse reaction on the bond market to a fiscal policy announcement or an unfavourable data print could do it.

Such a rapid, knee-jerk reaction would be the most painful for global markets and most likely would come with a stock market correction, if not an outright bear market.

Or the market could unravel slowly, as the weight of debt servicing limits the government’s ability to fulfill its economic role in an economic downturn. This scenario would probably be accompanied by a wave of downgrades, or at least negative outlooks from the major credit agencies, pressuring Washington to address the issue.

As Churchill quipped, “You can always count on Americans to do the right thing—after they’ve tried everything else.” Let’s hope we’re nearing that moment.

Section 5: Trading U.S. treasuries on unstable grounds

In the bond market, beauty is fleeting—and danger, persistent. Nowhere is this more evident than in the U.S. Treasury market, where investors are navigating a volatile mix of fiscal excess, shifting monetary winds, and structural uncertainty. The One Big, Beautiful Bill (OBBB) may have been designed to stimulate growth and secure political capital, but its side effects are rippling through the yield curve with increasing force.

A curve under pressure

The U.S. Treasury curve has become a battleground between short-term relief and longterm anxiety. In early 2024, short-term yields surged above 5% as the Fed held firm in the face of sticky inflation. But as growth slowed and disinflation gained traction, the Fed pivoted, cutting rates in the back half of the year. Front-end yields have since retreated below 4%, offering a modest reprieve for risk assets.

The long end tells a different story, however. Tenyear yields climbed to about 4.8% in January 2025, and 30-year bonds hover near 5%—both near multiyear highs that reflect a rising term premium. Investors are demanding more compensation to hold duration in a world where fiscal policy is loose, inflation risks linger, and the Fed is no longer the buyer of last resort. As can be seen below, the 10- year term premium has helped push rates up by about 200 bps over the past 24 months.

The shape of the curve reflects this tension. The 2s– 10s spread, once deeply inverted at nearly -100 basis points, has moderated to about -50 bps. Meanwhile, the 5s–30s segment has steepened sharply— recently near 90 bps—as markets price in a slowergrowth future and a Fed that may be nearing the end of its tightening cycle.

The return of the term premium

For much of the post-GFC era, the term premium was mostly declining—suppressed by quantitative easing, global savings gluts, and safe-haven flows. But it’s back, and with a vengeance. Since mid-2024, estimates suggest the term premium has risen by about 100 bps, driven by four interlocking forces:

1. Fiscal supply shock: The Treasury is issuing at a pace never before seen outside wartime. Net issuance is expected to run between $1.3–1.5 trillion annually, with a growing share in longer maturities. Historical models suggest that a rise of one percentage point in the debt-to-GDP ratio adds up to 3 bps to the 10-year term premium— outside QE regimes. With the U.S. debt ratio up about 20 points since Covid, the math points to a structurally higher premium.
2. Inflation uncertainty: Headline CPI has cooled from its 2022 peak of 9% to about 2.5%, but the path forward remains murky. Structural forces (tight labour markets, deglobalization, energy transition) are keeping inflation expectations sticky.
3. Political uncertainty: The independence of the Federal Reserve, probably the most important financial institution on Earth, is being challenged by the White House. Any fear of politicization of monetary policy hurts investor confidence.
4. The possible end of the safe-haven era: In past crises, Treasuries rallied hard—think early Covid, the euro zone crisis, or even the 2011 debt-ceiling standoff. But, with the U.S. fiscal outlook deteriorating and global reserve managers diversifying away from the dollar, that reflexive bid is weakening. Investors no longer assume that Treasuries will always rally in risk-off scenarios. That shift changes the calculus and raises the yield floor.

Demand is still there but softening

Despite the deluge of supply, Treasury auctions are still finding plenty of buyers. June’s 20- and 30-year auctions saw strong foreign demand after a softer May. But the market is making the government pay: Yields are often higher than what the Treasury expects, especially at the long end.

Foreign buyers, after shedding Treasuries in 2022–2023, have returned in 2025, with total holdings topping $9 trillion. But the composition is shifting. Appetite is strongest for T-bills, which now make up about 15% of foreign holdings, the highest level since 2010. This shift reflects a preference for liquidity and growing caution about long-term U.S. fiscal risks. Policy shifts abroad, such as Japan’s rising yields and China’s reserve diversification, add further uncertainty to the long-end demand picture.

On the domestic front, U.S. money market funds are eagerly absorbing the flood of new T-bills, helping stabilize the front end. But this demand is rate-sensitive and could fade if the Fed cuts more aggressively or if risk appetite returns.

Strategic implications: Duration is no longer a free lunch

For investors, the message is clear: U.S. Treasuries might no longer be the safe asset they once were. The combination of heavy issuance, rising term premia, and diminished safe-haven flows means that long Treasuries now carry more risk, and less ballast, than in the past.

That doesn’t mean Treasuries are uninvestable. But it does mean that positioning must be more tactical, more valuation-aware, and more attuned to fiscal dynamics.

In a world where the Fed is stepping back and the Treasury is stepping up, the long end of the curve is no longer just a reflection of growth and inflation; it’s a referendum on fiscal credibility.

Positioning

We are maintaining our overweight in equities, supported by strong earnings and reduced geopolitical noise, despite ongoing macro and tradepolicy uncertainty. In the U.S., earnings momentum remains solid, with expectations for continued EPS and PE growth. The artificial intelligence investment cycle continues to surprise on the upside, reinforcing large-cap earnings and valuations.

Even though we still see upside in U.S. and Canadian equities, we are tilting our overweight position toward emerging markets to enhance diversification. Equities outside the U.S. outperformed in the first half, and we expect this trend to continue, though at a slower pace. A weaker greenback has supported U.S. exporters and firms with foreign revenue, including mega-cap tech. Companies are adapting to tariff risks, and markets appear less reactive to headlines, partially pricing in announced tariffs. This backdrop supports a risk-on stance, though we remain cautiously optimistic, maintaining modest tail-risk protection as sentiment grows euphoric.

We also added an overweight in gold as a hedge against geopolitical, trade, and fiscal risks. Beyond its defensive role, sustained central bank demand remains a structural driver of gold prices.

We remain underweight fixed income, especially long duration. Even though bonds offer diversification, the risk-reward remains unattractive. U.S. fiscal dynamics are a concern, with rising deficits and questions about Fed independence adding tail risks. The Fed is in no rush to ease, inflation is contained, and growth remains resilient. Markets are pricing in two cuts by year-end but may be disappointed, given trade uncertainty and economic strength.

In currencies, we have closed our discretionary FX positions—previously expressed through overweights in the CAD, euro, and yen. These trades were initiated progressively over the first half of 2025 and were based on a thesis of medium-term USD weakness supported by cyclical and structural factors. However, recent market dynamics have moved against this view, prompting us to exit the positions. We continue to monitor fiscal policy, inflation, and central bank signals closely as we reassess the macro landscape.