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Tariffs are expected to persist beyond the current day, with future market focus likely shifting to taxes and the budget. President Trump has pledged to reduce the deficit, a key concern for numerous members of Congress.
Challenges lie ahead, as Reuters indicates that the Senate budget committee must increase the deficit by $1.5 trillion over a decade. This move aims to prolong the Trump tax cuts that are set to expire at the end of the year.
Fiscal Policy Expectations
This article outlines a direction in fiscal policy that is likely to remain relevant for several weeks. The extension of tariffs appears assured, suggesting that trade-related pricing pressures are unlikely to diminish in the near term. Attention is gradually turning toward fiscal matters, particularly tax reforms and the government’s budget goals. The President has stated a need to reduce the deficit, which several lawmakers also view as a priority. However, the legislative route taken—namely, the expansion of the federal deficit to permit extended tax reductions—presents a direct contradiction to that goal.
We understand from Reuters that a $1.5 trillion gap over ten years is currently being floated by the Senate budget committee. The intention is to sustain the tax reductions established under the previous administration, which are otherwise set to lapse by the end of the calendar year. The size and timing of the proposed fiscal support—framed here through tax policy—puts upward pressure on yields, as markets begin to price in longer-term borrowing.
This activity has already influenced options prices on both Treasuries and short-term rates. Long gamma exposure has started to recede, particularly at the front end of the curve, where realised volatility came in under expectations last week. The uptick in realised moves across 2-year and 5-year tenors, however, has not been sufficient to defend long premium holders, many of whom rolled into May expiry and are now reducing positions.
In put skew, we see notable steepening further down the curve. That likely reflects increased interest in hedging duration risk amid a fiscal regime that is becoming inflationary by design. Traders holding steepeners have accelerated their capital rotation, favouring directional expressions via payer spreads and back ratio structures.
Market Positioning Shifts
We are also observing changes in the demand for convexity. The bid for receiver protection at the long end has started to fade. That adjustment coincides with market participants digesting the curve repricing brought on by deficit-linked issuance projections. Higher expected supply exerts pressure on term premium premium, with current vol markets implying wider day-to-day moves around the 10-year point.
Derivatives participants may find value in revisiting recent strategies connected to fiscal expansion themes. It is worth noting that past fiscal packages led to short bursts of realised volatility, particularly when combined with signals from the Treasury regarding auction adjustments or longer-dated issuance. With uncertainty now focused on Senate proceedings and their timetable for renewal of the tax code, those holding short-dated straddles may choose to reduce gamma and rotate into longer expiry strategies that allow more time for a final resolution.
The playbook used during previous stimulus cycles—front-end flatteners, bear steepeners along the 10s30s, tactical volatility purchases through payer ladders—has re-emerged in recent positioning data. That said, the current fiscal numbers are materially larger, which calls for adjustment in sizing and tenor selection.
In the near term, liquidity pockets around scheduled Budget Committee announcements should be anticipated. Participants will be assessing both the stated deficit ceiling and how the upper chamber intends to fund the shortfall. Any emergence of triggers related to debt ceiling politics—especially as headline attention builds—would likely lead to increased demand for downside tails. For these reasons, longer-duration hedges may offer a cleaner expression than short-expiry volatility in the coming weeks.
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