Markets on alert as Trump administration targets tax reform and deficit reduction

Stephen Dover

As the Trump administration gets ready to focus on its dual agenda of pushing through new tax cut legislation while tackling the growing federal deficit, investors are gearing up to ongoing market volatility and sector-specific impacts from the proposed fiscal policies.

According to Stephen Dover, Chief Market Strategist and Head of Franklin Templeton Institute, “Congress must act which requires building legislative coalitions. While this may appear less exciting than topics such as DOGE and tariffs, it could be of greater significance for investors.”

Republicans recognise the political imperative to pass legislation extending provisions of the 2017 tax cuts that otherwise expire and would therefore impose a significant and unpopular tax hike on many Americans next year. They are also aware that they must pass legislation to fund the government’s operations.

“The requirements of ordinary governance are now likely to supersede the politics of executive orders, suggesting a very different environment for investors over the coming months,” Dover adds.

“The passage of legislation to extend or expand tax cuts and fund legislation will likely be a heavy lift for Congress. And it could take months of difficult negotiations among Republicans in the House of Representatives and the US Senate.

“That means that if market conditions worsen due to economic weakness, in our view, timely legislative intervention is unlikely. Investors expecting solid market returns for the remainder of 2025 based on new tax and spending legislation from Congress may have to be patient to see those anticipated outcomes.”

Part of the legislative challenge is the narrow Republican majorities in Congress, above all in the House of Representatives. While many Republicans favour tax cuts, some demand significant spending cuts to accompany them. These cuts can only be achieved through reforms to entitlement programs like Medicaid, which serves many Republican voters in rural communities.

What does this mean for investors? “Two things strike us as likely,” Dover says. “Firstly, existing tax provisions of the 2017 code will be extended. Secondly, the political will to pass large tax cuts, which must be financed by painful budget cuts, is probably impossible to achieve this year.”

“In our view, tax cuts are unlikely to help the economy or markets, and the Federal Reserve is likely to remain on hold until it feels comfortable that inflation will recede once tariff impacts filter through the data. If US growth and earnings expectations stumble, neither fiscal nor monetary policy appears in a position to offer quick relief.

“Investors are probably relieved that uncertainties of Trump’s first 100 days of DOGE cuts and tariff are receding. But in many respects, the hard work is just beginning, requiring significant effort and political skill to deliver the outcomes investors hope to see.”