The new tax bill will make it possible for U.S. multinational corporations to repatriate their liquid assets stored overseas. In theory this would simply be a wash since they currently hold the cash in the form of investments in bonds, so the repatriation could be as simple as telling a bond broker who is their Custodian to simply move the assets to another account based in the U.S. in which case the broker simply makes an accounting entry. However, the move will mean a lesser need for gross borrowing, even if the move doesn’t change the amount of net borrowing. (By net borrowing, I mean the amount borrowed net of the trapped offshore cash). Currently a multinational starves its headquarters of foreign earned cash and makes up for the lack of imported cash by borrowing domestically. When these borrowings are no longer needed then these debts will be paid off, thus reducing the pool of borrowers, making interest rates drop. The type of company that will benefit from the new tax bill are the most prosperous ones with the best credit ratings. Thus for the highest quality tiers of corporate debt I expect their spread over Treasuries to narrow, making rates for them lower than now. This could create a news “headline” where naïve investors would leap to the conclusion that rates are dropping merely because the rates for the highest quality corporate bonds dropped.
The typical corporate bond is of lower credit quality than the bonds issued by multinationals with huge offshore profits. These less credit worthy borrowers may not see any benefit of the change in bond market conditions in terms of a change in rates. However, if bond investors who experience a payoff of high quality bonds issued by a multinational, and they need to reinvest in corporate bonds then these investors may be forced to move downscale in credit quality. The risk they may take is they buy BBB rated corporates on the eve of a recession and then some of these bonds “migrate” downward one notch in credit quality, into junk territory, which means a reduction in their value.
Bond expert Gundlach has mentioned that corporate bonds are not as good of a relative value as mortgage backed bonds. I think the fundamentalist view of that is that corporations may be inclined to get ruthless and file bankruptcy when they have negative income, but residential borrowers, including landlords, are often able to hold on longer to a money losing business venture (or owner occupied homeownership plan) and have more hope of a future price recovery so these borrowers are intrinsically less risky than corporate borrowers.
The risk of owning mortgages is convexity caused by rising duration (as borrowers decide to not refinance frequently and instead hold on to the debt for the maximum term) that can occur if yields rise. However, if the macroeconomic picture is that the economy has topped out at the end of a 9 year cycle in a few months then bond duration will be shorted as borrowers seek to refinance and bond prices will rise during recession.
The risk of being hurt by a return of inflation and rising rates is less than the risk that the credit bubble problems of 2008 never really got fixed, and the risks that debts are even bigger (especially in China, Japan, Europe, and the UK), the risk the Fed can’t cut rates very much in the next recession and thus there may be a classic setup to a recessionary crash with declining yields and rising bond prices, along with rising defaults of low credit quality bonds.
The Muni market may be affected by the new tax bill where a shortage of Munis develops due to new restrictions on issuance of private activity bonds and pre-refunded bonds. This will make Muni yields decline, making Muni bond prices rise. This might be an asset class to increase allocation to as long as one avoids bonds at the lowest grade of investment grade rating, to avoid the risk that they decline in rating to a junk rating during a crash.
The big picture is that the tax cut bill will increase the deficit by $150Billion a year, about 0.75% of current federal debt. That’s less than inflation, so in theory the Treasury debt load is shrinking by 1% in real terms (helping to lower interest rates), which is deflationary both for the U.S. and for EM countries that need to hold dollars as a form of reserve currency. These EMs are already in a risky situation where their currencies could go down in value in a global recession and then just when they most need access to dollars would be when there is a dollar (T-Bill) shortage. The impact of the bill is actually non-stimulating and borderline deflationary as it transfers income to wealthy people who are less likely to spend (reducing total consumption by members of society). The bill would put downward pressure on home prices in expensive areas by taking away some tax benefits of home ownership. This may be needed to deflate the housing bubble, but it could trigger a recession.
Investors need independent financial advice about the risk of being fooled by the tax cut bill.