After months of bluster, the administration finally appears on the verge of passing a significant piece of legislation that could affect the bond market.
The bluster is over and tax cuts are on the cards but will it boost stocks?
(Image credit: 2017 Getty Images)
"The chance to slash the US corporate tax rate to 20% from 35% seems much more pleasant to contemplate than nuclear war," says Randall Forsyth in Barron's. So it's no wonder Wall Street decided to ignore North Korea's latest, more powerful missile and concentrate on the package of tax cuts and reforms produced by the US Senate last Saturday. After months of bluster, the administration finally appears on the verge of passing a significant piece of legislation.
The key elements of the package are the corporate tax cut, a discounted tax rate on foreign profits to encourage firms to bring their overseas cash piles home, and the closure of several loopholes. The bill still needs to be reconciled with the version proposed by the House of Representatives, which should occur by Christmas. The package will add yet more debt to America's fast-growing pile: another $1 trillion or so over ten years.
The tax package could give stocks additional momentum, although given the endless discussion of the topic over the past year, the odds are that most of the boost is priced into America's now extremely expensive equities. UBS Wealth Management is pencilling in a $10 per share boost to S&P 500 profits, so the index's constituents will earn a total of $151 per share in 2018 rather than $141.
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
Still, earnings have rebounded strongly in any case following a dip in 2015-16, and half the sales of the index's constituents are made abroad, so the global outlook is just as important as the US one. And while Bank of America Merrill Lynch expects a boost to US growth of 0.3% in 2018 owing to the tax bill, the world economy "is growing robustly, and in unison, for the first time since the financial crisis", as Rob Cox notes on Breakingviews.
The effect on bonds, however, could be far more significant. This package comes as the economy "is already at or close to capacity", says Hamish McRae in The Independent. Growth reached an annualised 3.3% in the third quarter, and the labour market is very tight. Adding fuel to the fire now could lead to a nasty jump in inflation. That would be a shock to absurdly overpriced bonds, especially since everyone thinks inflation has disappeared and central bankers almost always fall behind the curve.
We were in exactly this situation in the 1960s, adds John Plender in the Financial Times, with inflation apparently vanquished, the labour market tight, and fiscal and monetary policy extremely loose. Inflation had reached 6% by 1970. Today, long-term interest rates are already creeping up as the growth outlook has improved. But this tax package "will definitively put an end" to the 36-year Treasury bull market.
Sign up for MoneyWeek's newsletters
Get the latest financial news, insights and expert analysis from our award-winning MoneyWeek team, to help you understand what really matters when it comes to your finances.
Andrew is the editor of MoneyWeek magazine. He grew up in Vienna and studied at the University of St Andrews, where he gained a first-class MA in geography & international relations.
After graduating he began to contribute to the foreign page of The Week and soon afterwards joined MoneyWeek at its inception in October 2000. He helped Merryn Somerset Webb establish it as Britain’s best-selling financial magazine, contributing to every section of the publication and specialising in macroeconomics and stockmarkets, before going part-time.
His freelance projects have included a 2009 relaunch of The Pharma Letter, where he covered corporate news and political developments in the German pharmaceuticals market for two years, and a multiyear stint as deputy editor of the Barclays account at Redwood, a marketing agency.
Andrew has been editing MoneyWeek since 2018, and continues to specialise in investment and news in German-speaking countries owing to his fluent command of the language.
Revolut launches its first stocks and shares ISA with BlackRock and Vanguard ETFs
What does Trump’s ‘Big Beautiful Bill’ mean for the US economy?
