USD: Tax related revival? – Rabobank

Talk of US tax reform provided the USD with a boost on Tuesday, though the impact has already waned and going forward changes in tax policy certainly have the potential to underpin the greenback, though this assumes certain critical provisos can be met, according to Jane Foley, Senior FX Strategist at Rabobank. 

Key Quotes

“This year’s heavy unwind in long USD positions suggests that currently the USD should be more susceptible to good news than to bad.  At the end of last year the USD was lifted by optimism regarding fiscal reform which has been progressively unwound this year as failures by the Republican Party to achieve anything other than gridlock doused market optimism.”

“There is the potential for changes in taxation to be pushed through with bi-partisan support.  This, however, will only be possible if the Democrats manage to win some compromises in the agenda.”

“Earlier this month US National Economic Council Director Cohn made it clear that tax reform has become a major priority for the Trump administration.  The White House proposed that Republicans should reach out to Democrats who represent regions where Trump was successful in November with the aim of piecing together a bi-partisan package. This month Senate Minority Leader Schumer and Wyden, the top Democrat on the Senate Finance Committee, released a letter signed by 45 of the 48 Senate Democrats calling on Trump to launch bi-partisan talks. These Democrats hope to be able to draw tax reform towards their agenda and deliver relief to middle class families without tax cuts for the rich.  This could mean more overall support for consumption which would be USD positive.  That said, the FX market is likely to pay particular heed to news concerning any potential changes on the handling on US companies’ offshore profits.”

“The White House and Republicans have signalled a desire to scrap the practice of taxing US companies on their worldwide earnings rather than their domestic income alone.  There is also a desire to cut corporation tax.  Since the US’s 35% corporate tax is only payable when income is repatriated, this has led to speculation of huge offshore holdings by US companies.  It has recently been reported that Apple is holding around USD246 bln offshore, Microsoft USD116 bln and Cisco USD 62 bln.  The Trump campaign had proposed a one-off levy of 10% on repatriated earnings to coincide with any changes in corporate tax.  Although it is unclear whether US companies are holding offshore earnings in USD or in other currencies, it is conceivable that any large scale repatriation could trigger a surge in demand for USDs.”  

“The White House push for tax reform is set to be complicated over the next few months by compromises needed to prevent a government shutdown and a theoretical debt default.  While in theory tax reform has the potential to boost the USD, so many conciliations would have to be made in Washington for a substantial change in fiscal settings that, for now, the market is set to continue viewing this outcome as difficult to achieve.”

“Near-term the USD is likely to continue to be bogged down by scepticism over the will of the Fed to hike rates again this year and by the continued rotation back into the EUR.  This is driven in part by expectation that on the back of strong economic data the ECB will rein in its QE programme next year.  We expect EUR/USD to trend towards 1.20 by the middle of next year.”