The Republican tax plan unveiled Wednesday seeks to spark economic growth through lower rates but could punish one key market area: U.S. government bonds.
A key provision of the reform plan calls for the repatriation of cash that multinational companies are holding overseas. While details remain thin, foreign holdings will get softer tax treatment when they are brought home. Companies have about $2.5 trillion stashed abroad.
Treasurys fit into the equation because much of that overseas money is held in cash, cash equivalents or short-term investments — a category that includes government debt.
So, when companies start pulling that money back to the U.S., that presumably would mean selling of Treasurys, a move that would push up yields. Buyers will be needed for those bonds as government debt and deficits increase, which also could see a demand for higher rates.
"A lot of attention is bound to focus on the implications for U.S. equities of the Republicans' updated tax reform 'framework,'" John Higgins, chief markets economist at Capital Economics, said in a note.
"Nonetheless, the implications for U.S. government bonds could also be significant if the framework includes President Trump's previous plans to impose a repatriation tax on the retained foreign earnings of US multinational enterprises and end the deferral of taxes on corporate income earned abroad."
The tax plan does just that, though the exact taxation levels are still uncertain.
According to an outline the GOP issued, the new structure "ends the perverse incentive to keep foreign profits offshore by exempting them when they are repatriated to the United States." The new plan will include "rules to protect the U.S. tax base by taxing at a reduced rate and on a global basis the foreign profits of U.S. multinational corporations."
Higgins used Microsoft as an example of what will happen. The software giant is holding about $133 billion in cash, equivalents and short-term investments, almost all of which is held by foreign subsidiaries. The company is a leader among Russell 1000 firms in terms of offshore cash. Should the company participate in the repatriation program, that will create a new supply of debt that could drive up rates.