Tax reform and the
reflation trade

Feb 13, 2017 / By Richard Turnill

Key points

  • U.S. corporate tax reforms could reinforce a reflationary environment already in place before last November.
  • Some “Trump trades” partly unwound early last week, while political uncertainty sent French and Italian bond spreads wider.
  • Fed Chair Janet Yellen’s testimony before Congress this week could raise market expectations of a March Fed rate increase.

Our preference for reflation beneficiaries – or assets likely to benefit from rising growth and inflation – isn’t contingent on U.S. corporate tax reform. Yet such reform does have the potential to amplify this market theme.

Median effective U.S. corporate tax rates, 2016

Median effective U.S. corporate tax rates, 2016

Sources: BlackRock Investment Institute and Bloomberg, February 2017.
Notes: The bars show median effective corporate tax rates based on firms' latest fiscal-year earnings releases. Mega caps are the top-10 largest firms in the S&P 500 as measured by market cap. Mid caps are represented by the Russell Mid Cap Index and small caps by the Russell 2000 Index.

One example: We see reflation supporting more gains in U.S. small cap stocks. They typically outperform during periods of rising rates, as we note in our Global Equity Outlook. Tax cuts would be an extra boost disproportionally benefiting small caps, given those corporations’ higher effective tax rates.

Tax reform winners and losers

The reflation trade has waxed and waned since November along with expectations for U.S. tax reform. But any tax reforms this year should only reinforce a reflationary environment already in place before the U.S. presidential election. Significant uncertainty shrouds the final tax plan, and the need to find offsetting revenue means tax reform will create winners and losers.

The border tax adjustment would effectively subject imports to a 20% tax to help pay for any corporate tax cut. Proponents argue the U.S. dollar should rise in response, offsetting the impact on trade or consumer prices. We see only a partial currency adjustment, which could help exporters and hurt retailers and consumers. How the U.S. dollar behaves in such a scenario will be key for markets and the U.S. economy.

We also believe another proposed reform, scrapping the deductibility of interest expense, would ultimately hurt highly leveraged companies and have major implications for how companies finance themselves in capital markets. Without offsetting revenue, large corporate tax cuts would increase the deficit, creating a reflationary stimulus that could lead to higher interest rates. We see potential for volatility in the coming months as more reform details emerge.


  Date: vertical line Event
Feb. 13-17 European firms, mainly defensives and financials, report earnings
Feb. 14 U.S. NFIB Small Business Optimism Index; China Consumer Price Index (CPI)
Feb. 14-15 Fed Chair Janet Yellen gives her semiannual monetary policy testimony before Congress
Feb. 15 U.S. retail sales, U.S. CPI

Markets are likely to react to any signals from Yellen regarding a March Federal Reserve rate rise, the odds of which we believe markets may be underpricing. NFIB’s report will show if small business owners’ economic confidence remains at a 12-year high.

  • Some “Trump trades” partly unwound amid policy uncertainty. Emerging market (EM) assets outperformed, U.S. Treasury yields fell sharply mid-week and U.S. value stocks underperformed a flat market.
  • Political uncertainty sent French and Italian government bond yields to multi-year highs relative to their German peers. Half of the European firms that have reported earnings have beaten estimates.
  • Oil fell to a near three-week low under the pressure of growing U.S. crude inventories, but pared some losses. China’s PMI data showed expansion in both services and manufacturing sectors.

Global snapshot

Weekly and 12-month performance of selected assets


EquitiesWeekYTD12 MonthsDiv. Yield
U.S. Large Caps 0.9% 3.5% 25.1% 2.1%
U.S. Small Caps 0.8% 2.4% 46.3% 1.5%
Non-U.S. World 0.3% 4.6% 22.5% 3.1%
Non-U.S. Developed 0.0% 3.5% 18.5% 3.3%
Japan 1.0% 4.4% 24.8% 2.0%
Emerging 1.2% 7.9% 30.3% 2.7%
Asia ex-Japan 1.5% 8.4% 25.3% 2.6%
BondsWeekYTD12 MonthsYield
U.S. Treasuries 0.4% 0.5% -1.8% 2.4%
U.S. TIPS 0.5% 1.0% 4.0% 2.1%
U.S. Investment Grade 0.5% 0.6% 5.9% 3.3%
U.S. High Yield 0.1% 2.0% 24.5% 5.8%
U.S. Municipals 0.2% 0.9% -0.5% 2.5%
Non-U.S. Developed -0.9% 0.9% -1.9% 0.8%
Emerging Market $ Bonds 0.6% 2.7% 14.0% 5.5%
CommoditiesWeekYTD12 MonthsLevel
Brent Crude Oil -0.2% -0.2% 83.9% $56.70
Gold 1.1% 7.5% 3.0% $1,234
Copper 5.5% 10.0% 37.0% $6,090
CurrenciesWeekYTD12 MonthsLevel
Euro/USD -1.3% 1.2% -5.7% 1.06
USD/Yen 0.5% -3.2% -0.1% 113.22
Pound/USD 0.1% 1.2% -14.0% 1.25

Source: Bloomberg. As of February 10, 2017.
Notes: Weekly data through Thursday. Equity and bond performance are measured in total index returns in U.S. dollars. U.S. large caps are represented by the S&P 500 Index; U.S. small caps are represented by the Russell 2000 Index; Non-U.S. world equity by the MSCI ACWI ex U.S.; non-U.S. developed equity by the MSCI EAFE Index; Japan, Emerging and Asia ex-Japan by their respective MSCI Indexes; U.S. Treasuries by the Bloomberg Barclays U.S. Treasury Index; U.S. TIPS by the U.S. Treasury Inflation Notes Total Return Index; U.S. investment grade by the Bloomberg Barclays U.S. Corporate Index; U.S. high yield by the Bloomberg Barclays U.S. Corporate High Yield 2% Issuer Capped Index; U.S. municipals by the Bloomberg Barclays Municipal Bond Index; non-U.S. developed bonds by the Bloomberg Barclays Global Aggregate ex USD; and emerging market $ bonds by the JP Morgan EMBI Global Diversified Index. Brent crude oil prices are in U.S. dollars per barrel, gold prices are in U.S. dollar per troy ounce and copper prices are in U.S. dollar per metric ton. The Euro/USD level is represented by U.S. dollar per euro, USD/JPY by yen per U.S. dollar and Pound/USD by U.S. dollar per pound. Index performance is shown for illustrative purposes only. It is not possible to invest directly in an index. Past performance is not indicative of future results.

Asset class views

Views from a U.S. dollar perspective over a three-month horizon

Table: Asset class views from a U.S. dollar perspective


Richard Turnill
Global Chief Investment Strategist, BlackRock Investment Institute
Richard Turnill is Global Chief Investment Strategist for BlackRock. He was previously Chief Investment Strategist for BlackRock’s Fixed Income and active Equities business ..
Kate Moore
Chief Equity Strategist