Trump's Fiscal Gambit: Tax Cuts, Military Spending, and the Market's Crossroads

The fiscal landscape of the United States is poised for a dramatic shift under President Donald Trump's proposed $6 trillion tax overhaul and a $1.5 trillion military budget for 2027. These measures, framed as a blend of economic populism and geopolitical assertiveness, raise profound questions about the sustainability of U.S. fiscal policy and their implications for investor sentiment. By examining historical precedents-from the Cold War to post-9/11 spending surges-we can better assess how these proposals might reshape defense stocks, Treasury yields, and equity market volatility.

Defense Stocks: A Double-Edged Sword

Trump's call for a 66% increase in defense spending has already triggered a sharp rally in defense sector stocks. Shares of major contractors like Lockheed Martin and Raytheon surged by 7.9% and 4.8%, respectively, following the announcement of the $1.5 trillion budget. This reaction mirrors historical patterns: during the post-9/11 era, defense stocks similarly benefited from expanded procurement contracts and R&D funding. However, the current context introduces unique risks. Trump's threats to curtail dividends and stock buybacks for underperforming contractors-Raytheon being a prime target- add a layer of political volatility. While long-term defense contracts typically stabilize earnings forecasts, the administration's aggressive stance on corporate behavior could create short-term whipsaw effects, as seen in the rapid fluctuations of defense stocks during Trump's 2017–2021 tenure.

The sustainability of this rally also hinges on the feasibility of Trump's funding model. Tariff revenue, which rose from $98.3 billion in 2024 to $288.5 billion in 2025, is touted as a key offset. Yet, fiscal watchdogs warn that these revenues may fall short, particularly if the Supreme Court deems some tariffs unconstitutional. If the administration cannot bridge the gap between spending and revenue, defense contractors may face pressure to absorb costs or face reduced profitability-a scenario that could dampen investor enthusiasm.

Treasury Yields: The Fed's Tightrope

The proposed tax cuts and military spending are projected to add $5.8 trillion to the national debt over a decade. Historically, such fiscal expansions have had mixed effects on Treasury yields. During the Cold War, the Federal Reserve actively managed yields by pegging interest rates at artificially low levels, even as defense spending surged to 10% of GDP. This interventionism kept yields stable despite rising deficits. However, the 1980s demonstrated the limits of such policies: when inflation spiked to 15.7%, the Fed was forced to raise rates to 20%, triggering a bond market crash.

Today's environment is more complex. While Trump's tax cuts and deficits may theoretically push yields higher, the Fed's accommodative stance- exemplified by its 2020 rate cuts to 0.93%-suggests yields could remain suppressed. Yet, this stability is contingent on global economic conditions. If the U.S. dollar weakens due to fiscal overreach or trade disputes, foreign investors may demand higher yields to compensate for risk, echoing the 2001–2011 period when the ICE US Dollar Index fell 34% amid widening deficits. The administration's reliance on tariffs as a revenue source further complicates the outlook, as legal challenges could disrupt investor confidence and trigger yield spikes.

Equity Volatility: War, Warnings, and Waning Certainty

Equity markets have historically exhibited reduced volatility during periods of heightened defense spending. During the Cold War, the predictability of military contracts and R&D funding narrowed earnings forecasts for defense firms, stabilizing broader market expectations. Similarly, post-9/11 conflicts saw equity volatility decline as firms aligned with government priorities according to research. Trump's proposals, however, introduce a paradox. While the $1.5 trillion budget could replicate this stabilizing effect, the administration's broader tax agenda- projected to reduce revenue by $5–11 trillion over ten years-introduces uncertainty.

The 2025 tax bill, which permanently extends the 2017 tax cuts and raises the estate tax exemption, has already contributed to a $4.1 trillion deficit increase over a decade. Such fiscal profligacy risks eroding investor confidence, particularly if the debt-to-GDP ratio surpasses 132% by 2035. This contrasts with the Cold War era, where deficits were offset by economic growth and geopolitical stability. Today, the combination of tax cuts, trade tensions, and a fragile global economy may amplify volatility, particularly in non-defense sectors.

Conclusion: A Fiscal Tightrope

Trump's fiscal agenda represents a high-stakes gamble. The proposed military spending and tax cuts could bolster defense stocks in the short term but risk exacerbating long-term debt and deficit challenges. Treasury yields, while currently insulated by Fed intervention, may rise if fiscal discipline erodes or tariffs face legal hurdles. Equity volatility, historically tempered by defense spending, could diverge if the broader economy falters under the weight of these policies.

History offers no simple answers. The Cold War's managed deficits and post-9/11 fiscal surges demonstrate that defense spending can stabilize markets-but only when paired with credible revenue sources and monetary discipline. Trump's reliance on tariffs and tax cuts, however, lacks the robustness of past strategies. For investors, the key lies in balancing the immediate tailwinds for defense stocks with the looming risks of fiscal overreach. As the administration's policies unfold, the market's response will hinge on whether these measures are perceived as a bold new era or a precarious gamble.