On the US Senate's Changes to the 'Revenge Tax' and More

1.) Section 899 – The Senate Version

a.) Late last Monday, the Senate GOP released its own version of the ​“One, Big, Beautiful Bill Act” (OBBBA). You can read the text of the bill here (Section 899 starts on page 138).

We see a few important deviations between this text and the House GOP version of the Section 899 provision:

• There is a clear exemption for portfolio interest.
• The applicable rate is capped at 15% over three years.
• The implementation date has been pushed to January 1^st, 2027.

Our take: This is clearly a more watered-down version of the provision relative to the House GOP bill. 

The delay in implementation tells us that the US wants more time to negotiate with ​“discriminatory countries”. The lower cap implies that the GOP isn’t really looking at Section 899 as a meaningful contributor to long-term revenues. 

So, reading between the lines, the Senate’s version implies that Section 899 is more about extracting leverage and/​or a bargaining chip for bilateral trade talks.

b.) In Canada, affected businesses have to declare and file digital service tax payments for 2022, 2023 and 2024 by June 30, 2025.

That is a mere two weeks from today.

One thing to monitor is what the Canadian government does ahead of this deadline.

c.) Other notable difference between the House and Senate versions of OBBBA can be found here.

The SALT cap is going to be a very contentious – primarily because Senate GOP members are focused on finding revenue offsets and none of them are from states where a rise in SALT caps will do much.

2.) On the Fed changes to eSLR: Bloomberg reports that US bank regulators are looking to reduce the eSLR (or the Enhanced Supplementary Leverage Ratio) for banks by up to 1.5%.

For those wondering, the eSLR is regulatory ratio that is calculated by taking a bank’s Tier 1 capital and dividing it by its total leverage ratio. The minimum for a US GSIB is 3% plus a 2% buffer (or 5%). The new minimum requirement would be 3.5% if the Bloomberg story is to be believed. The Fed will likely deliberate on this further, but expect Chair Powell to be asked about it later today.

If true, this would mean that US banks have more room to intermediate in the US Treasury market – where concerns about liquidity have arisen over the past few years. With a lower ratio, banks wouldn’t have to set aside as much capital to invest in USTs. 

Treasury yields are lower, while swap spreads remain in recent ranges. That tells us that part of this story is already in the price. 

3.) The ​‘micro risks’ you should be watching – Part II

Earlier this week, we spoke a bit about the bizarre idea of turfing one of the Fed’s more critical monetary policy levers – the interest it pays on reserve balances to banks. That’s an idea that appears to have garnered some interest (pun intended) on Capitol Hill. Ultimately, it’s a bad idea that will make it impossible for the Fed to do its job without tanking the market. 

Another bad idea that is gathering steam amongst politicians is an end to US dollar swap lines. To summarize these are facilities set up by the Federal Reserve to ensure that foreign central banks (which cannot print US dollars) have the ability to exchange their own currencies for US dollars during times of need.

Indeed, foreign central banks have found these facilities incredibly useful in mitigating volatility during the global financial crisis as well as the Covid-19 shock. For all the talk about the world shifting away from the US dollar as a reserve currency, people often forget that the USD still accounts for over 60% of global export invoicing. Additionally, over US$12trln in non-domestic currency debt is denominated in US dollars. There is still an overwhelming need for many market participants to source USD.

So imagine a world in which the Fed elects to weaponize this facility (potentially after Chair Powell leaves office next year). Right now, there are permanent swap agreements in place between the Fed and five other central banks for maturities that range from overnight to 3-months. If the Fed wanted to weaponize this facility it could do anything including:

• Change the parameters and offer US dollars at a premium to the market rate.
• Elect to shutter these swaps altogether.

Ultimately though, weaponizing US dollar swaps is yet another bad idea. The easiest way to conceptualize this is to remember that any central bank that cannot source US dollars will turn to its next source – it’s reserve holdings (which likely mostly consists of US Treasuries). Selling UST to raise US dollars would (in theory) lead to a rise in UST yields – tightening credit conditions for the US government and the private sector. 

And if there is one thing that scares this current administration – it’s an untoward rise in US Treasury yields.