U.S. Fiscal Outlook Improves Amidst Significant Tax and Banking Reforms

Market Overview: Fiscal Improvement and Policy Shifts

The U.S. Treasury Secretary Scott Bessent announced that the nation concluded fiscal year 2025 with an improved deficit-to-GDP ratio, a key indicator of fiscal health. The ratio is projected to fall from 6.5% to 5.9% for the fiscal year ending September 30, a reduction from what was previously cited as the highest level outside of wartime or recessionary periods. This development underpins an optimistic outlook for the U.S. economy in 2026, driven by a recently enacted comprehensive tax bill and significant proposed banking regulatory reforms.

Comprehensive Tax Legislation Fuels Economic Optimism

The "One Big Beautiful Bill Act" (OBBBA), signed into law in July 2025, represents a significant legislative effort aimed at stimulating various sectors of the economy. This wide-ranging tax legislation includes net tax cuts of $4.5 trillion and spending cuts of $1.2 trillion, resulting in a projected cost of $3.3 trillion over a decade. The legislation is anticipated to increase long-run Gross Domestic Product (GDP) by 1.2% and raise average after-tax incomes for taxpayers by 2.9% in 2025 and 5.4% in 2026, with the latter reflecting the full impact of permanent individual tax provisions from the 2017 Tax Cuts and Jobs Act (TCJA).

Key provisions benefiting businesses include the permanent allowance for domestic research and development (R&D) expensing, 100% bonus depreciation for qualifying investments, and the permanency of the Qualified Business Income (QBI) deduction. These measures are designed to encourage corporate investment in property, plant, and equipment, including manufacturing facilities. On the consumer front, the OBBBA makes permanent many individual tax changes from the TCJA, such as lower individual tax rates and a larger standard deduction. It also introduces a more generous State and Local Tax (SALT) deduction cap, temporary deductions for tips and overtime pay, and an increased Child Tax Credit of $2,200 per child, adjusted annually for inflation. Secretary Bessent specifically anticipates "substantial tax refunds" for lower-income consumers in early 2026, which are expected to bolster consumer spending.

Banking Sector Set for Regulatory Overhaul

Treasury Secretary Bessent highlighted the administration's intent to significantly revamp the banking industry's regulatory framework. A core objective is to reduce capital requirements for mortgages and corporate credit, aiming to re-route lending from non-bank entities back to traditional banks. This move seeks to counter the effects of the post-2008 Dodd-Frank regulatory framework, which Bessent argues has adversely impacted the community bank model. Since 2010, the U.S. has seen a reduction of over 45% in community banks, with their share of outstanding bank loans decreasing from 27% to 20%.

The proposed reforms target a modernization of the capital framework to eliminate capital arbitrage, likely entailing reduced capital requirements for large banks on certain loans. Importantly, the administration plans to ensure parity by offering smaller banks the option to benefit from these reduced requirements. Broader changes include narrowing the "Basel Endgame" capital hikes, reducing capital surcharges for systemically important banks, and overhauling annual stress tests. Amanda Eversole, CEO of the Financial Services Forum, emphasized the potential of these reforms, stating, "America's largest banks are the strongest in the world... Modernizing capital rules will let them put that strength to work – fueling growth for consumers, small businesses, and the economy."

Reforming Fannie Mae and Freddie Mac: Balancing Access and Stability

The Trump administration is also aggressively pursuing reforms for government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac, aiming to conclude their 17-year conservatorship and enhance liquidity in the mortgage market. Efforts are underway for a smooth transition, with the Federal Housing Finance Agency (FHFA) and the U.S. Department of the Treasury having amended Preferred Stock Purchase Agreements in January 2025. The GSEs are actively building capital, having accumulated nearly half of the approximately $330 billion combined capital required.

Discussions revolve around various models, including the Treasury converting its preferred holdings to common stock or a partial privatization where the government retains an implicit guarantee. The latter is projected to result in a smaller increase in mortgage rates, around 20 basis points, compared to a full privatization without a government guarantee, which could see rates rise by up to 80 basis points. The Treasury Department has underscored that any actions taken on Fannie Mae and Freddie Mac must not increase borrowing costs and must preserve features like the prohibition on volume-based discounts for large lenders and the cash window, which are crucial for ensuring equal secondary market access for small lenders. Fannie Mae projects the 30-year mortgage rate to end 2025 near 6.5% and 2026 near 6.3%, reflecting ongoing market adjustments and reform impacts.

Market Implications and Forward Outlook

The combined impact of an improved fiscal outlook, broad-based tax relief, and significant banking sector reforms presents a nuanced but largely optimistic picture for the U.S. economy. The anticipated tax refunds are expected to provide a short-term boost to consumer spending, while business tax incentives could stimulate corporate investment, particularly in manufacturing and R&D. This positive fiscal and policy environment is likely to underpin market confidence.

However, the detailed implementation and long-term effects of the banking regulatory changes, especially regarding the balance between increased lending and potential risks for community banks, remain areas of focus. Investors will be closely monitoring the new Basel draft anticipated by early 2026 and further specifics of the Fannie Mae and Freddie Mac reforms. The interplay of these policies will be crucial in shaping the trajectory of the Banking Sector and the broader Financial Sector in the coming quarters, with attention also paid to consumer spending patterns and corporate earnings reports as the tax benefits fully materialize.