The Hole in the Boat… | April 27, 2018

‘Cut taxes’ they said, ‘it will be fun’ they said, nobody told them it could crash the bond market…

Tax reform is providing us some much-needed respite from the volatility created by inflation concerns and tariff talk. As we go through the corporate earnings season, 53% of companies have reported and earnings are projected to increase at a rate of 23.2% for the quarter[1].  The problem tax reform poses, however, is the cost. Estimates put the expense between $1T – $1.5T. No matter where it lands in that range, it is too much to pay at this stage of the economy.

The Federal Reserve Board (FRB) has desperately been looking for ways to unload the balance sheet and increase interest rates. The balance sheet still sits just below $4.5T and is on a schedule to decrease to $2T by 2022. That is right, 2022. The FRB is attempting to lift rates to a level that would provide them a way to lower rates and provide relief in the next recession.

The problem is the timing of this debt creation. First you have to ask, how will we be paying for tax reform? Well, if there are not enough tax dollars, then we will just issue more bonds. Our plan is to increase our debt creation at a point where our biggest debt purchaser, the FRB, is saying they are going to buy less and less bonds over the next four years. Increased issuance with a decreased demand means that rates could accelerate much quicker than the FRB desires. This could cause them to increase rates at a higher pace causing a bond bear market. So while tax reform is an effort to accelerate the economy, it may actually cause the one thing it was striving to prevent, a recession.


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[1] www.mfs.com – week in review