Tax reform and the reflation trade

Global weekly commentary
13/feb/2017 / By BlackRock

Key points

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

1. Tax reform and the reflation trade

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.

Chart of the week
Median effective U.S. corporate tax rates, 2016

Chart of the week

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.



  • Some “Trump trades” partly unwound amid policy uncertainty. Emerging market 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.



  Date: 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.

Richard Turnill
Managing Director, is Global Chief Investment Strategist for BlackRock
Richard Turnill is Global Chief Investment Strategist for BlackRock. He was previously Chief Investment Strategist for BlackRock’s Fixed Income and active Equities business ...

This material is for distribution to Professional Clients (as defined by the FCA Rules) and should not be relied upon by any other persons.

Issued by BlackRock Investment Management (UK) Limited, authorised and regulated by the Financial Conduct Authority. Registered office: 12 Throgmorton Avenue, London, EC2N 2DL. Tel: 020 7743 3000. Registered in England No. 2020394. For your protection telephone calls are usually recorded. BlackRock is a trading name of BlackRock Investment Management (UK) Limited.

Sources: Bloomberg unless otherwise specified.

Past performance is not a guide to future performance. The value of investments and the income from them can fall as well as rise and is not guaranteed. You may not get back the amount originally invested. Changes in the rates of exchange between currencies may cause the value of investments to diminish or increase. Fluctuation may be particularly marked in the case of a higher volatility fund and the value of an investment may fall suddenly and substantially. Levels and basis of taxation may change from time to time.

Any research in this document has been procured and may have been acted on by BlackRock for its own purpose. The results of such research are being made available only incidentally. The views expressed do not constitute investment or any other advice and are subject to change. They do not necessarily reflect the views of any company in the BlackRock Group or any part thereof and no assurances are made as to their accuracy.

The opinions expressed in this paper may change as subsequent conditions vary. The information and opinions contained in this paper are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents.

This paper may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this paper is at the sole discretion of the reader.

This document is for information purposes only and does not constitute an offer or invitation to anyone to invest in any BlackRock funds and has not been prepared in connection with any such offer.

© 2016 BlackRock, Inc. All Rights reserved. BLACKROCK, BLACKROCK SOLUTIONS, iSHARES, BUILD ON BLACKROCK, SO WHAT DO I DO WITH MY MONEY and the stylized i logo are registered and unregistered trademarks of BlackRock, Inc. or its subsidiaries in the United States and elsewhere. All other trademarks are those of their respective owners.