Be careful what you wish for and check your reaction if you get it.
That could be a fitting mantra for the U.S. stock market over the past week, when prices swung wildly, ultimately plunging major indexes into the 10% correction that many had been waiting for but fearing at the same time. By Friday, major stock indexes had recovered slightly, but few think the volatility is over.
What many in the stock market had been wishing for was a big cut in U.S. corporate tax rates, which would help boost earnings and sustain a market rally that was already more than eight years old. Corporate tax rates were cut permanently along with temporary cuts in personal income taxes in the recent tax overhaul that is expected to add $1.5 trillion to the federal budget deficit over 10 years.
Then Congress last week passed a two-year spending bill, halting a five-and-a-half hour government shutdown and fulfilling the market’s wish. But the spending bill is expected to add several hundred million dollars to the deficit this year and next, pushing it over $1 trillion by 2019, according to the Committee for a Responsible Federal Budget. (The fiscal 2017 budget deficit was $666 billion).
Both moves are seen as feeding fears of rising inflation and putting upward pressure on interest rates, which were already heading higher on the expectation of more Federal Reserve rate hikes and the gradual reduction of the Fed’s $4.4 trillion balance sheet, aka quantitative tightening.
Even White House Budget Director Mick Mulvaney said Sunday in a TV interview that the U.S. could see a “spike” in interest rates this year as a result of a rising deficit. He added that the recent tax cuts could boost growth in the long term and reduce deficits, but few economists on Wall Street or in academia share that forecast.
(Related: Stocks Plunge, Market Enters Correction)