CICC: After the "Big Beautiful" bill is passed, $1 trillion will be siphoned off in the third quarter, presenting a buying opportunity for U.S. stocks and bonds

In the past three months, despite concerns about "de-dollarization" and the "triple whammy" of stocks, bonds, and currencies, the U.S. stock market has outperformed global markets and reached new historical highs. The Nasdaq rebounded 35% from its lows, U.S. Treasury yields did not rise further, and although the dollar remained weak, it did not decline as sharply as feared. After a brief outflow, funds returned to the U.S. stock and bond markets.

This performance is also consistent with our recent key viewpoints: We indicated near the bottom on April 8 that the Nasdaq's valuation had dropped to around 20 times P/E, making it gradually attractive, and at least it should not be shorted anymore; during the peak of concerns about the "triple whammy," we pointed out that these worries were more due to short-term liquidity shocks and some long-term concerns based on extrapolated expectations.

Chart: Since the bottom in April, the U.S. stock market has outperformed global markets and reached new historical highs.

Source: FactSet, Bloomberg, CICC Research Department

Chart: Overseas equity funds slightly outflowed from U.S. stocks in April and then flowed back in.

Source: EPFR, CICC Research Department

Chart: Overseas bond funds also outflowed from U.S. Treasuries in April, but began to flow back in since mid-May.

Source: EPFR, CICC Research Department

Regarding the relationship between U.S. stocks and the dollar, there are two obvious misconceptions in the market: One is equating a weaker dollar with "de-dollarization," and the other is equating a weak dollar with falling U.S. stocks. Regarding de-dollarization, we suggest that this crowded consensus may face short-term issues and recommend paying attention to the possibility of a slight rebound in the dollar in the fourth quarter and U.S. stocks outperforming again.

We do not fully agree with this consensus viewpoint, not only because this expectation is too crowded and based on a grand narrative that cannot be confirmed or falsified in the short term, but also because of our judgment that the U.S. credit cycle may restart in the fourth quarter: In addition to investments in new industries represented by AI and traditional U.S. demand after the Federal Reserve cuts interest rates, the quarter-on-quarter improvement in fiscal policy is also an important driver, as confirmed by the recent passage of the "Great Beauty" Act.

Of course, from the other side of the coin, the passage of the "Great Beauty" Act will also release bond supply on a quarterly basis (debt ceiling opened), which, under the circumstances of already high expectations for U.S. Treasuries and stocks, a small wave of inflation in July-August, and the Federal Reserve not being able to cut rates quickly, will push up U.S. Treasury yields. If the rise is too fast or too much, it may disturb sentiment and U.S. stocks, which needs attention, and is a "hurdle" that U.S. stocks and bonds need to overcome in the third quarter However, this is just a short-term liquidity disturbance, which does not change the credit cycle recovery and the Federal Reserve's interest rate cut pattern, so the volatility can actually provide better buying points for both U.S. stocks and U.S. bonds.

Chart: Inflation in July-August may see a slight increase due to base effects and tariff price transmission.

Source: Haver, China International Capital Corporation Research Department

Chart: CME interest rate futures imply that the Federal Reserve may cut interest rates in September.

Source: CME, China International Capital Corporation Research Department

In this article, we will analyze how the "One Big Beautiful Bill Act" affects the outlook for U.S. bonds and stocks from the perspectives of its fiscal and credit cycle impacts on the economy, as well as its liquidity effects on bond supply.

What does the "One Big Beautiful Bill Act" include? Resolving the debt ceiling, extending tax cuts, cutting spending, and repealing Clause 899

After several rounds of negotiations (the House of Representatives passed it on May 22, and the Senate passed its revised version on July 1), the "One Big Beautiful Bill Act" (OBBBA) was passed by the House of Representatives on July 3 with a narrow margin of 218:214. Trump officially signed it during the U.S. "Independence Day" celebration on July 4, marking the formal enactment of this highly anticipated bill. The final version includes the following key points:

Chart: Key points of the final version of the "One Big Beautiful Bill Act"

Source: CFRB, China International Capital Corporation Research Department

► Raising the debt ceiling. Since the beginning of the year, the U.S. has reached its debt ceiling. Before resolving this, the Treasury could only meet necessary payment demands by depleting its existing cash reserves (TGA, Treasury General Account). The TGA has been reduced from $840 billion at the beginning of the year to $300 billion. The Treasury previously estimated that it would face an "x" day in August [1] (the date when the Treasury would exhaust all cash and special measures and be unable to meet all payment obligations). Therefore, the "One Big Beautiful Bill Act" raises the debt ceiling by $5 trillion, allowing the Treasury to continue issuing bonds to meet refinancing and new spending needs. The current U.S. government debt stands at $35 trillion, accounting for 117% of GDP. Assuming GDP remains unchanged, the debt ratio after the increase will rise to 135% Chart: The current debt of government departments accounts for 117% of GDP

Source: Haver, China International Capital Corporation Research Department

► Extend the 2017 tax cut law set to expire at the end of this year, which permanently extends individual provisions for personal income tax and child tax credits, 100% accelerated depreciation, and corporate provisions for R&D expense deductions. Compared to the version passed by the House in May, the final version of the tax cut provisions significantly increases support for businesses. Although the tax cut law is more of an extension of the 2017 provisions rather than a substantial addition, it effectively avoids the drag on the economy from a fiscal cliff-style contraction.

► Cut spending on electric vehicle subsidies, healthcare, and food stamps by $1.4 trillion, the "Great Beauty" Act balances the overall deficit by cutting spending, such as the elimination of certain provisions in Biden's Inflation Reduction Act, like the electric vehicle credits, which will be abolished starting September 30. This is also a major point of disagreement between Musk and Trump [2].

► Cancel Clause 899, which is one of the reasons the market is concerned that the U.S. may tax overseas investors' investments in U.S. Treasury bonds, increasing the selling pressure on U.S. Treasuries. In our outlook for the second half of the year, we analyze that even if Clause 899 is passed, its impact is not as significant as the market fears, but its direct cancellation can better alleviate overseas investors' concerns about selling pressure on U.S. Treasuries.

What are the economic implications of the "Great Beauty" Act? Avoid fiscal contraction and boost the credit cycle; but due to tariff revenue, it will not expand support significantly

The core implication of the "Great Beauty" Act for the economy is: on one hand, it avoids the drag of fiscal contraction on the economy; at the same time, due to increased tariff revenue offsetting spending, it will not lead to the feared significant expansion of the deficit, alleviating market concerns about fiscal and debt sustainability. Specifically,

► On one hand, fiscal expansion continues, especially with an improvement in fiscal pulse quarter-on-quarter in the second half of the year. In February this year, Musk led the Department of Government Efficiency (DOGE) to cut costs by reducing federal employees and canceling federal contracts. Although there has been no substantial fiscal contraction, the "fiscal convergence narrative" has strengthened, leading to a "low point" in fiscal expectations, which is one of the three macro pillars supporting the U.S. economy.

Thanks to this, the U.S. credit cycle is expected to gradually improve in the second half of the year, and even expand again, which is the main basis for our judgment that the dollar will strengthen slightly and U.S. stocks will outperform. 1) Government credit improves; although the overall fiscal expansion is not large, compared to the low base in the first half of the year, the fiscal pulse in the second half may improve to 0.6%. 2) Private credit is expected to restart; after the Federal Reserve cuts interest rates, the recovery of traditional private sector demand (such as real estate), combined with the tax cut policy boosting corporate investment, leads us to estimate that the year-on-year growth rate of corporate social financing is expected to rise to 3.3% in the fourth quarter, while the household sector remains basically flat. Overall, the private sector credit pulse will continue to rise starting in the third quarter and turn positive by the end of 2025 Chart: The overall private sector credit impulse in the United States will continue to rise starting from the third quarter and turn positive by the end of 2025.

Source: Haver, CICC Research Department

Chart: The general deficit impulse in the U.S. for fiscal year 2025 may turn negative, improving to 0.6% in fiscal year 2026.

Source: EPFR, CICC Research Department

► On the other hand, the increase in tariff revenue can largely offset expenditures, keeping the deficit rate around 6% in the coming years. According to CBO forecasts, the "Big Beautiful" Act is expected to increase the basic deficit by $3.4 trillion over the next 10 years, with a total deficit including interest payments of $4.1 trillion, higher than the earlier version from the House of Representatives (basic deficit of $2.4 trillion). Referring to CBO's forecast, the deficit in fiscal year 2026 is expected to increase by about $479 billion, but thanks to annual tariff revenues of $300-400 billion that can offset most of it, the deficit rate will rise from 5.2% in fiscal year 2025 to 5.9% in fiscal year 2026, maintaining around 6% in the coming years.

Chart: The deficit rate rises slightly from 5.2% in fiscal year 2025 to 5.9% in fiscal year 2026.

Source: Haver, CICC Research Department

Chart: Daily data shows tariff revenue of $69 billion from April to June.

Source: Bloomberg, CICC Research Department

What are the liquidity implications of the "Big Beautiful" Act? Short-term increase in bond supply, with a net issuance of $1 trillion in the third quarter, similar to the third quarter of 2023.

The flip side is that after resolving the debt ceiling, the supply of government bonds will also be released again, creating a liquidity drain, expected to be mainly reflected in the third quarter. The reason it is mainly concentrated in the third quarter is that after resolving the debt ceiling, the Treasury needs to quickly replenish its depleted "wallet" TGA, while some bond issuance demand that had accumulated due to the debt ceiling constraints will also be released instantly. Conversely, looking further ahead, this concentrated bond issuance supply pressure is actually controllable. We estimate that the tariff revenue in fiscal year 2026 ($300-400 billion) can largely offset the new deficit of $479 billion from the "Big Beautiful" Act, with the overall deficit scale in fiscal year 2026 expected to be about $1.8 trillion How significant is the supply pressure in the third quarter? Our estimate shows a net issuance scale of approximately 1 trillion USD. The issuance of government bonds is divided into two parts: the first part is "borrowing new to repay old," with the peak maturity of 4.4 trillion USD in May-June having passed, and the maturity scale from July to September is around 3.6 trillion USD, of which 2.6 trillion USD is short-term debt, thus refinancing pressure has eased compared to the second quarter. The second part is new issuance, with a scale of about 1 trillion USD, based on the budget deficit from July to September (400-500 billion USD), TGA replenishment scale (550 billion USD), and other financing needs (75 billion USD).

Chart: TGA replenishment needs about 550 billion USD from July to September

Source: U.S. Department of the Treasury, CICC Research Department

A similar situation occurred in 2023, where the peak in bond issuance after resolving the debt ceiling quickly pushed up U.S. Treasury yields. 1) Comparable scale: After resolving the debt ceiling on June 3, 2023, the U.S. Department of the Treasury planned to issue an additional 1.01 trillion USD in the third quarter; 2) Rising rates: The 10-year U.S. Treasury term premium increased by 120bp within three months, pushing U.S. Treasury yields from 3.8% to 5%. 3) Issuance structure dominated by short-term debt: In the 1.01 trillion USD additional bonds issued in the third quarter of 2023, only 158 billion USD were medium- and long-term interest-bearing bonds, while the remaining 850 billion USD were all short-term debt. Although the net issuance scale in the third quarter of 2025 is similar to that of the third quarter of 2023, the proportion of medium- and long-term bonds in the current financing plan is significantly higher than in 2023 (467 billion USD in the third quarter of 2025 vs. 158 billion USD in the third quarter of 2023).

Chart: The issuance plan for the third quarter of 2023 shows a net bond issuance scale of 1.01 trillion USD, of which 850 billion USD is short-term debt

Source: U.S. Department of the Treasury, CICC Research Department

Chart: The financing plan released in April by the U.S. Department of the Treasury shows a net issuance scale of medium- and long-term bonds of about 467 billion USD in the third quarter

Source: U.S. Department of the Treasury, CICC Research Department

Chart: The net bond issuance scale in the third quarter is approximately 1 trillion USD, similar to the scale in the third quarter of 2023

Source: U.S. Department of the Treasury, China International Capital Corporation Research Department

However, the increase in the issuance ratio of medium- and long-term bonds does not imply a higher term premium for long-end U.S. Treasuries. On one hand, under the current U.S. Treasury yield levels, issuing more medium- and long-term bonds is not cost-effective, a viewpoint recently echoed by Treasury Secretary Janet Yellen [3]; on the other hand, after the "reciprocal tariffs" in April, the 10-year U.S. Treasury term premium once rose to 0.8%, exceeding the October 2023 peak of 0.5%, reaching a new high since July 2014, reflecting investors' concerns about the creditworthiness of the U.S. dollar.

What impact will this have on U.S. Treasuries and U.S. stocks? The liquidity "drain" in the third quarter may cause disturbances, but volatility will provide reallocation opportunities.

After the debt ceiling was lifted in June 2023, the third quarter immediately entered a peak period for bond issuance, with supply pressure reflected in the 10-year U.S. Treasury term premium, which rose by 120 basis points within three months, pushing U.S. Treasury yields from 3.8% at the end of June to 5%. The S&P 500 index corrected by 4% during this period, with earnings contributing 4% and valuations dragged down by high interest rates by 8%. The U.S. dollar index rose by 3.3%, from 102 to 106.

Chart: After the debt ceiling issue was resolved in the third quarter of 2023, the 10-year U.S. Treasury term premium drove nominal interest rates up by 120 basis points.

Source: Bloomberg, China International Capital Corporation Research Department

Currently, the third quarter is once again facing a similar peak in bond issuance, coupled with inflation rising in July and August due to base and inventory factors, as well as the current high sentiment in the U.S. Treasury and stock markets, volatility cannot be ruled out.

► In the short term, liquidity drain may cause disturbances and transmit to U.S. stocks through U.S. Treasuries. 1) U.S. Treasury yields: If we compare to the extreme increase of 120 basis points from the bottom of U.S. Treasury yields in the third quarter of 2023, an additional increase of 80 basis points from the current 4.3% would break through 5% (having already risen 40 basis points since April). However, this comparison may be too mechanical; on one hand, the current term premium is already high, with the term yield before the increase in 2023 being negative (-0.8%), while currently it has reached as high as 0.9%, a new high since July 2014. On the other hand, the outflow of funds from U.S. Treasuries after the "reciprocal tariffs" in April was more than twice that of the third quarter of 2023, so even with increased supply pressure in the third quarter, it may not be that extreme. 2) U.S. stock valuations: During the interest rate surge phase from the end of June to mid-October 2023, high interest rates led to a significant contraction in valuations (dragging down by 8%), but U.S. stock earnings still grew by 4%, so the overall correction was not that large. Assuming other conditions remain unchanged, if the 10-year U.S. Treasury yield breaks through 4.8%, it will drag the S&P 500 valuation down from the current 22.3 times to 20.3 times, a decrease of about 9% Chart: The outflow after the "reciprocal tariffs" in April is more than twice that of the third quarter of 2023

Source: EPFR, Bloomberg, CICC Research Department

► In the medium term, short-term liquidity shocks do not change the long-term view, and volatility instead provides allocation opportunities. 1) The rise in U.S. Treasury yields will tighten financial conditions, and coupled with the Federal Reserve's interest rate cuts, can provide reallocation opportunities. Under the baseline scenario, we expect the Federal Reserve to cut interest rates twice this year, corresponding to a Treasury yield center of around 4.2%. The current U.S. real interest rate (1.78%) is still 0.78 percentage points higher than the natural rate (1%), indicating that the Federal Reserve needs to cut rates. However, since tariff negotiations have not yet been finalized, the pace may need to wait until the tariffs are implemented in September and uncertainties dissipate before rate cuts can begin. 2) The restart of the U.S. credit cycle is the main support and driving force for U.S. stocks, benefiting from strong AI investments, a month-on-month improvement in government fiscal impulses, and the restart of traditional demand in the private sector after rate cuts. Based on two rate cuts this year and a rebound in profit growth to 9% (with tax cuts offsetting tariff drag), we estimate the S&P 500 index center to correspond to 6000~6200 points.

Chart: Two Federal Reserve rate cuts correspond to a Treasury yield center of around 4.2%

Source: Bloomberg, Haver, CICC Research Department

Chart: The S&P 500 center at 6000~6200, if rates return to the 2023 bond issuance peak corresponds to 5500 points for the S&P 500

Source: FactSet, CICC Research Department

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The market has risks, and investment requires caution. This article does not constitute personal investment advice and does not take into account the specific investment goals, financial conditions, or needs of individual users. Users should consider whether any opinions, views, or conclusions in this article are suitable for their specific circumstances. Investing based on this is at one's own risk