Looking further out, corporate credit may still remain a suitable play in the environment ahead. Barclays analysts predict that the Republican administration’s far-reaching tax reforms could boost the market by curbing the post-financial crisis jump in leverage for industrial issuers, which could buoy returns over the next decade, Bloomberg reports.
“A cut to the tax rate would increase the cash flow available to companies to service debt and, thus, improve credit quality,” the Barclays analysts wrote in a recent note. “Furthermore, we expect companies to decrease leverage because the tax shield benefit of debt would be reduced at lower tax rates, effectively increasing the after-tax cost of debt.”
As lower taxes provide companies with more power to service debt obligations from the new source of cash flow, the reduction in the tax rate would make borrowing in the bond market less appealing relative to equity funds, which would encourage companies to reduce gearing ratios. The reduced supply of corporate debt would help sustain current corporate bond prices.
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