The far-reaching Tax Cuts and Jobs Act that Congress passed on Dec. 20 is likely to affect institutional investors for years.
Among the most significant provisions is the cut in the corporate tax rate to 21% from 35%, which is expected to sustain the ongoing nine-year stock bull market.
And while GDP was a relatively healthy 3.2% for the third quarter, there are concerns the nearly $1.5 trillion the tax overhaul could add to the deficit could dampen economic health in the longer term.
For the bond market, and investors in it, the tax bill has more consequences.
The bill encourages U.S. corporations to repatriate billions in cash from overseas affiliates. Flush with cash, some companies might opt to put more money into their pension funds. But they also might issue fewer bonds, a move that would mean fewer bonds for pension funds — especially those looking to derisk their plans — to buy. Bank of America Corp. estimated the supply of investment-grade bonds could be cut by up to 17% next year.
While higher deficit projections mean more Treasury debt for investors, the question of yield remains a concern.
The tax bill puts a 30% limit on corporations' deductions of interest paid, so while high-grade companies will have cash and fewer reasons to borrow, the tax change would make the cost of borrowing higher for lower-rated entities, making them also less likely to sell bonds.
That could lead to investors competing for fewer bonds, pushing prices up and yields down, affecting returns.
For certain university endowments, the tax bill means a new 1.4% excise tax on net investment income.
Time will tell on all these impacts, but it is safe to say 2018 will be a busy year for institutional investors.
