Effect of Tax Cuts

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President Trump today said to expect an announcement about tax cuts in two to three weeks. Mortgage rates moved a little higher after the comment. There are two reasons why tax cuts are viewed as negative for mortgage rates.

  • The first is that tax cuts increase the wealth of the affected individuals or businesses, leaving them with more money to spend. This added spending boosts economic activity, which increases the outlook for future inflation. Mortgage rates rise as expected future inflation rises, since higher inflation further erodes the value of a mortgage’s future cash flows.
  • The second is that tax cuts increase the budget deficit, at least initially. This means that the government has to issue more Treasury bonds to fund the deficit. The added supply reduces the value of Treasuries and similar bonds, including mortgage-backed securities (MBS). A decline in MBS prices leads to higher mortgage rates.