News flow remains bullish

This article is more than 12 months old

Tax reform in US moving closer to reality while the Fed is poised to hike interest rates after a meeting next week

The latest news flow over the weekend continues to be positive for stock market bulls.

In the US, tax reform is moving closer to reality, even while interest rates are poised to go up again amid a strong economy.

Separately, oil markets have cheered after oil cartel Opec and other oil-producing countries, including Russia, agreed to keep production cuts throughout 2018.

On Saturday afternoon in Asia, the US upper chamber, the Senate, agreed on a sweeping tax reform bill two weeks after the lower chamber, the House, had done so.

The clearest benefits of the tax bill will flow to businesses. Corporate taxes will go down from 35 per cent to 20 per cent, among other things.

As for individuals, the overall impact is mixed.

While individual tax rates will be reduced and the number of tax brackets simplified, deductions on state and local income taxes will also be eliminated, with the exception of a deduction of up to US$10,000 (S$13,500) a year for state and local property taxes.

Meanwhile, political squabbling over raising the government debt ceiling might be delayed until later this month to give House and Senate politicians time to reconcile the two tax reform bills they have.

There are two possible financial effects of US tax reform.

First, tax cuts are generally perceived to be a boost for the economy, even while there is anxiety that the benefits will accrue to the richest.

So US stocks, which continue hitting new highs, might continue their ascent.

Some economists, however, are sceptical that tax reform will boost the economy as much as the Republicans claim.


"The non-partisan Tax Policy Center estimates that the level of gross domestic product (GDP) would only be 0.3 per cent of GDP higher than it would otherwise be if the House bill passes. That equates to less than 0.03 percentage points a year over 10 years," wrote Mr Jeremy Lawson, chief economist at Standard Life Investments.

The debate will also revolve around how much spare capacity there is left in the US economy.

The stimulus to demand from tax cuts might be offset by US rates rising faster, Mr Lawson said.

Secondly, with fiscal stimulus, it is possible that the US dollar can rise after depreciating substantially this year.

After all, the Federal Reserve is poised to raise interest rates after a meeting next week. The target range is likely to rise to 1.25 per cent to 1.5 per cent.

On the sidelines, there are worries of the yield curve inverting, which is a signal of a recession.

This is because the US 10-year Treasury yield is just 2.36 per cent. With a December hike, three more hikes in the overnight rate next year might bring the short end up to 2.25 per cent.

But Mr Philip Wee, foreign exchange strategist at DBS Group Research, thinks the fears are overdone.

"US stock markets have been achieving record highs on stronger US gross domestic product growth throughout the year. We disagree with the US recession fears the market associated with a flatter yield curve," he said in a Friday note.

As for oil, while blue chip oil-linked stocks such as Keppel Corporation and Sembcorp Marine have recovered, the sector will only experience a sustained recovery with more contract wins, said OCBC Investment Research last Friday.

It likes Keppel and the Sembcorp names, but remains "neutral" across the sector "given continued unease over the small-mid cap space".