Last week, during a press conference following the Federal Reserve's decision to cut rates by 25 basis points, something we had forecast, J. Powell was asked about the US government debt. He stated that while the current level of US government debt is sustainable, the trajectory of that debt is not. This comment has sparked a discussion on how the Trump presidency, with its emphasis on cutting corporate taxes, will impact the US budget deficit.
Looking ahead, the US budget deficit for 2026 will be drafted in 2025 when both the presidency and Congress — the Senate and the House of Representatives — are all under Republican control. Interestingly, the Speaker of the House, Mike Johnson, who is part of the conservative Freedom Caucus, has made it clear that he wants to reduce the size of the US budget deficit. This will be a key issue moving forward.
The US budget deficit has been a frequent topic of conversation because it can serve as an indicator of trends in the commodity cycle. For instance, the most recent low in the deficit occurred in 2022, at 3.9% of GDP, signalling the bottom of the cycle for commodities. However, the budget deficit rose to 7.6% of GDP in 2023, and for the current year, it is expected to peak at 7.63% of GDP. This suggests that the peak in commodity prices may occur around 2026.
A significant part of the discussion centres on President Trump's promise to reduce US corporate tax rates to 15%. This is the same corporate tax rate as Germany. The potential cost of this tax cut is substantial, with estimates ranging from $460 billion to $673 billion. For the sake of discussion, if we assume the cost is around $500 billion, the impact on the US budget deficit will be significant. Currently, the US deficit is estimated to be $2.2 trillion, or 7.3% of GDP, and projections for next year remain the same.
Sustainability in terms of the US budget deficit is generally considered to be a level that matches GDP growth. Given that US GDP growth is expected to be around 2%, the deficit could realistically be about $600 billion, much lower than the current $2.2 trillion. This creates a significant challenge for policymakers, especially since cutting spending will likely be the key to reducing the deficit.
Mike Johnson, as part of the Freedom Caucus, will push for cuts in government spending, and President Trump has appointed Elon Musk to assist in finding opportunities to streamline government expenses. Musk, who is known for his ability to cut costs in companies like Tesla and X (formerly Twitter), will look for inefficiencies in government spending, even though the "Department of Government Efficiency" he is heading will exist only as an advisory body. Nevertheless, Musk’s skill and reputation for cost-cutting could play a crucial role in helping to bring down the deficit.
The push to reduce the budget deficit while implementing tax cuts will be a central focus in the lead-up to the 2026 US budget. The proposed corporate tax cuts to 15% will add roughly $500 billion to the deficit, but they are expected to increase after-tax corporate earnings, which should drive stock prices higher. This contrasts with the Democrats' proposal to increase corporate taxes, which would likely lead to a sell-off in the stock market and a potential recession in the following year.
If the Republican-led government can successfully reduce the budget deficit while implementing corporate tax cuts, it could be a significant boost to both the US economy and the stock market in 2026.
.jpg)
