US tax cuts may produce a ‘sugar rush’ and create a recession later

SLASHING taxes may give the US economy a temporary boost but the “sugar rush” may cause deeper problems ahead, investors at the Reuters Global Investment 2018 Outlook Summit in New York said.

US equities have rallied this year, partly on hopes that promises by President Donald Trump to cut taxes will come to fruition. But while investors at the summit thought a cut would continue to boost equities and help corporations, some questioned whether the timing was right and worried about the impact on the country’s deficit.

“I worry about a sugar rush which you crash harder from,” said Gregory Peters, a managing director and senior investment officer at PGIM Fixed Income. “I don’t know if it’s necessary at this point.”

Republicans in the US House of Representatives and the Senate earlier this month unveiled duelling proposals to slash corporate taxes to 20 percent from 35 percent. The House passed its version on Thursday, and a Senate committee voted to send its version to the full Senate, which will take it up after the Thanksgiving holiday on November 23.

Peters said the US was at a “point in the cycle where fiscally you’re supposed to get your house in order”, adding that if it deteriorated fiscally “your fiscal impulse when you need it most isn’t available”.

The US economy has been showing steady but underwhelming annual growth since the last recession in 2007 to 2009 while the S&P 500 Index has risen around 15 percent.

While investors typically are not forecasting a near-term recession they see a risk from expanded stock market valuations which could cause a correction and have a ripple effect on the economy. While on the campaign trail in 2016, Trump forecast a “very massive recession” in the US.

Joachim Fels, global economic adviser and a managing director at Pacific Investment Management, said a recession could be hastened if Congress implemented tax cuts that overstimulate the economy, and used up bullets that lawmakers could use to fight the next downturn. He said it could “pave the way for a short boom now… but possibly a recession in 2019 or 2020”.

“I don’t think we need a tax cut at this stage,” said Fels. “A tax cut at this stage is raising the risk of overstimulating the economy.”

Both measures would add $1.5 trillion (R21trlllion) over 10 years to the annual budget deficit and the $20 trlllion national debt, according to congressional tax analysts.

White House spokesperson Sarah Sanders said on Thursday that a new tax code would be “rocket fuel” for the economy.

BlackRock chief executive Larry Fink said his worry was the potential for a long-term problem from the foreign funding of US debt. China was the largest non-US holder of Treasuries while Japan was the second largest in August. – Reuters