EC All You Really Needed Was The Yield Curve

It is absolutely amazing the lengths people will go to in order to deny the most straightforward and obvious explanation; to torture and twist plain evidence. That’s the thing about rationalizing, though. The narrative usually matters more than the facts.

Take tax reform and interest rates. The problem with tax reform wasn’t actually tax reform. The Tax Cuts and Jobs Act of 2017 (TCJA) was chock full of good and reasonable ideas, measures that were desirable on their own merits.

Beside the government “allowing” you to keep more of your own money, the law also encouraged pension funds to do something about their chronic and growing shortfalls. Everyone knows that retirement plans have been depending upon fuzzy math related to investment returns (which can’t be predicted) to keep within even fuzzier guidelines about solvency.

The TCJA encouraged companies to actually set aside real reserves in order to at least partially and somewhat address this pretty hazardous reality. They were given a tax break: though the corporate tax rate was reduced to 21% from 35% as a result of the law, businesses with qualified plans would still be allowed to deduct pension contributions at the old rate.

Many of the world’s biggest firms did just that. A flood maybe even a deluge of new money headed into the portfolios of institutional pockets. And with these new funds there was demand for the safest assets; very much like insurance reserves, a large proportion of pension reserves are tucked away into UST’s and the like given their risk-averse core nature.

The tax break was scheduled to expire in September 2018. Naturally, given what was going on in 2018 this was seen as a huge deal – for the bond market; or, more precisely, because of what wasn’t going on. Everyone said interest rates had nowhere to go but up, and while they were rising they weren’t rising very fast or very far at the long end. The curve had flattened out dramatically.

It was signaling a warning at a time when there seemed no reasonable basis for one.

Jay Powell had said emphatically that inflation and accelerating economic growth were going to pressure bonds – a good thing, all things considered. Under the guise of the looming BOND ROUT!!!, this tax quirk seemed to many as a good explanation for why the curve had flattened when it shouldn’t have given the economic fundamentals as described uniformly by central bankers, Economists, and the mainstream media (redundant).

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Disclosure: This material has been distributed for informational purposes only. It is the opinion of the author and should not be considered as investment advice or a recommendation of any ...

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