uploads///

Tax Cuts and Rate Hikes Could Impact the Fed

By

Dec. 6 2017, Updated 1:50 p.m. ET

Impact on bond markets

The proposed tax cuts and the resulting increase in the federal deficit are expected to impact bond markets. It’s important to consider the Fed’s current stance. The Fed stated its intent to continue its monetary tightening path with a proposed rate hike this month and another three hikes in 2018. As a result, bond (BND) yields are poised to increase in the short term. With the prospect of tax cuts leading to an increased deficit, bond investors will likely demand higher yields for US debt in the future. If the tax cuts are implemented, they’re expected to increase savings and wages. The tax cuts could result in a higher rate of inflation (TIP) growth.

Article continues below advertisement

How did bond markets react?

Bond yields, especially in the short term, have increased in response to the heightened possibility of US tax reform. The immediate impact of the Senate passing the proposed tax bill was a bump in US Treasury bond yields, which have cooled off in the last two days. Tax cuts alone wouldn’t impact bond (AGG) yields. In the current economic climate, expected rate hikes and inflation (VTIP) growth would remain the key drivers for the bond (HYG) markets. In the long term, lower tax rates and the higher deficit could help make the yield (SHYG) curve steeper. The yield has been flattening since 2014. A flattening yield curve is considered to signal a future recession.

Tax cuts and the Fed

Tax cuts alone likely won’t sway the Fed from its current plans to tighten the policy. If the Trump Administration doesn’t unveil any additional stimulus plans, we can expect the US Fed to continue with its plans to increase interest rates. The only conditions that the Fed would be considering would be economic growth, employment, and inflation. Right now, we can expect one rate hike this month and three more next year.

In the next part of this series, we’ll analyze how tax cuts would impact equity markets.

Advertisement

More From Market Realist

  • Morgan Stanley sign and stock numbers
    Macroeconomic Analysis
    Morgan Stanley's Buyback Stock Picks in 2021
  • Black Wall Street sign is sign of ethical investing
    Macroeconomic Analysis
    Ethical Investing Stocks and Funds for Your 2021 Portfolio
  • New York City skyline and Goldman Sachs logo
    Macroeconomic Analysis
    Goldman Sachs: Options Trade Picks to Play Earnings Season Volatility
  • Woman working on a laptop
    Macroeconomic Analysis
    Why NOBL ETF Could Offer Upside Potential in 2021
  • CONNECT with Market Realist
  • Link to Facebook
  • Link to Twitter
  • Link to Instagram
  • Link to Email Subscribe
Market Realist Logo
Do Not Sell My Personal Information

© Copyright 2021 Market Realist. Market Realist is a registered trademark. All Rights Reserved. People may receive compensation for some links to products and services on this website. Offers may be subject to change without notice.