Question

There is more talk about tax cuts in the air, right on the heels of the 2017 Trump tax cuts. Are tax cuts good or bad for bond issuers and/or investors? That is, how would additional fiscal stimulus from more tax cuts affect the bond market?

Answer 1

Fiscal stimulus, such as tax cuts or increases in spending, will increase output and revenues in the short run by increasing overall demand. The stimulus should be prompt, immediate, and tailored, to have the greatest impact with the least long-run expense. Timely, because their impacts are felt when economic activity is still below potential; stimulation is ineffective when the economy has recovered. Temporary, to prevent increased inflation, and to reduce the long-term adverse effects of a larger budget deficit.

This is bad news for investors in debt mutual funds, especially those who invest in long-term bond funds and gold funds. Debt mutual fund managers expect bond funds could be affected in the coming time if the increase persists. Prices and bond yields shift in opposite directions. As the bond yield goes up, the debt schemes ' bond prices and NAVs fall.

Interest rate risk basically means that bond owners will impact their returns to varying degrees, based on the amount of interest rate fluctuation experienced. The amount of risk applied to a bond by interest rate changes depends on how much time it takes for the bond to maturity, and the coupon rate of the bond, or annual interest payment.