Find out why bluechips are safe, for now, and why a strong US inflation report is not enough to boost the languishing dollar.
The G7 finance ministers’ meeting dominated the weekend news agenda, however, at this early stage it is far too early to say if this “historic” deal to make multinationals pay more tax will have any impact on the stock market in the coming weeks and months. Below we will look at the important questions that still need answering, but in the short to medium term we believe that the ECB meeting, US inflation and what will happen next for GameStop, AMC and other meme shares along with Bitcoin will dominate the trading agenda.
A long journey to international taxation
Corporate tax rates are an important component when valuing a company’s share price. For the last 30 + years, most large multi nationals have been able to lower their tax bills by using perfectly legal methods such as booking large swathes of profits through low tax rate jurisdictions and tax havens along with jurisdictional blending. These reduced tax bills have been welcomed by the global financial markets and have contributed to stock market gains in recent decades. However, going forward we need to find out if changes in the corporate tax system and a push from the wider international political community to make the world’s largest companies pay more tax, will lead to a higher risk premium for equities. For now, the future of “international taxation” is hazy, and thus difficult to price in immediately. For example, this might have been agreed by the G7, however, it needs to be agreed by the G20 nations next month, and then by more than 130 nations who are in negotiations with the OECD. International taxation is difficult to sell to nations of different sizes and different levels of development, some say a global tax rate is too hard to achieve.
Will a global tax rate actually hurt multinationals, not at this level
But let’s say that it is agreed, even by US Congress who still have to pass any legislation that comes from the G7 agreement, will this hurt stock prices? We think that for now, the effect could be limited. After all, 15% is still a relatively low rate of tax. The impact could be felt more keenly on tax havens, or on low tax countries, who would find their tax advantage is eroded by an international minimum tax rate for multinationals. However, a 15% rate may be low, but if there is a political mechanism for implementing an international tax rate then it is entirely possible that the tax rate could be increased down the line. That is why, while stock prices may not be impacted right now, if an agreement can be reached by all 130+ nations at the OECD, and if there is a strong definition of what constitutes a multinational, if there is also agreement on a tax base, then a corporate tax risk premium will be added to blue chip global stocks, but we think that could be a few years off yet.
These are big questions, and ones that we don’t think will be answered in the coming weeks or months. From a short-term stock price perspective, we think that major multinationals will be safe from a sell off on the back of this news. Firstly, the Nasdaq, which contains a large number of multi nationals who could be in line for a tax hike if an international tax minimum is agreed, jumped more than 1.4% on Friday although this deal was on the cards. Amazon and Apple both saw gains on Friday, and it is questionable if Amazon would be in line for a major tax bill on the back of any international tax rate because Amazon is a retailer and doesn’t make too much profit since its profit margins are so thin.
German election could see EUR/USD uptick
Thus, we do not think that the G7 deal will impact markets too much. Instead, the euro could see an uptick on the back of success for Germany’s CDU party after it won a crucial vote in the eastern state of Saxony-Anhalt, decisively beating the far-right AfD party, and making it likely that the CDU’s leader, Armin Laschet, will succeed Chancellor Merkel in September. EUR/USD had already jumped above $1.2150 last week on the back of stronger inflation for the Eurozone, thus, this news could see the euro bulls try and push EUR/USD back towards $1.22 as we move towards the ECB meeting on Thursday. There is pressure on the ECB to at least consider tapering its EUR 80BN per month asset purchase programme now that Eurozone countries are exiting lockdowns and vaccination rates are taking off. The ECB has been adamant that higher inflation will be temporary and that it is too early to taper or talk about tightening monetary policy. However, any hint of a less dovish Lagarde this week could send the euro higher and cause German bond yields to start to rise again, the 10-year yield has fallen to -0.2% in recent weeks. If this happens then the Dax, which had a fairly good May rising from 15,200 to nearly 15,700, could be at risk. If EUR/USD does break that $1.22 level, beware a sell -off in the Dax.
US price rises may still not matter to the Fed
Elsewhere, US CPI is the other major data highlight this week. The markets went into a spin last month when April’s figures were released, this time prices are expected to rise even further, with the May headline CPI rate expected to come in at 4.7% up from 4.2% in April, while the core rate is expected to come in at a 3.4% annual rate, up from 3% in April. This is a large increase, and it will be interesting to see how the market balances out a weaker payrolls report for May, combined with a potentially stronger inflation report. We would note that wage pressure was building in the May labour market report, which suggests that the inflation impulse in the US is strong. Last month we saw US treasury yields jump on the back of the strong April inflation report, while stock market volatility rose and prices fell. We would expect to see a similar reaction this time, however, the impact could also be short-lived. For example, over the course of last month the 10-year US Treasury yield fell from 1.7% after the inflation report for April was released to 1.55% at the end of last week. If yields jump on the back of a strong inflation reading for May then it may temporary as it is still too early to know if rising inflation is here to stay or if it is a temporary phenomenon like the Fed thinks that it is. From a trading perspective, a strong inflation report does not mean that the dollar will rise, and we could see a subdued dollar for a few more months.
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