A Tax Cut Need Not Zap The Bond Market

The growing likelihood that Americans will be provided a modicum of tax relief in the coming election year has momentarily spooked the bond market, which fears that such fiscal blandishments inevitably involve a dose of higher inflation. But economist Nancy Lazar at International Strategy & Investment Group points out that the last two times taxes were cut significantly--in early 1975 and late 1981--stock prices, bond yields, and inflation all posted protracted declines.

In both cases, notes Hyman, taxes were cut because the economy was weak. "The current logic," she says, "is to sell bonds because reflating tax cuts are probably coming. However, past tax-cut episodes suggest that bond yields are still likely to move lower if the economy stays weak and inflation declines."

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