USD: Positioning for tax reform? – Rabobank

The markets have been waiting all year for some detail on US fiscal reforms and today President Trump and leading Republicans have promised to finally put some flesh on the bones of a new tax framework, according to Jane Foley, Senior FX Strategist at Rabobank.  

Key Quotes

“According to Trump, the proposals would cut taxes “tremendously” for the middle class, lower the corporate tax rate and bring back trillions of USDs invested overseas.  That said, press reports suggest that GOP leaders could be reluctant to face some of the more controversial decisions that could sink the plan and may avoid immediately naming some of the tax break that will be overturned to help pay for the programme.” 

“The market is expecting today to hear that the corporation taxes could be cut to 20% from 35%, that there will be a call to lower the rate many high income businesses pay through individual income tax to 25% and for the top tax bracket for individuals and families could be lowered from 39.6% to 35%. To prevent accusations that the rich could benefit the most, lawmakers could be asked to impose a new higher rate for the wealthy.   Together, the proposals will reportedly indicate that taxes will be cut by more than $5 trn over the next 10 years and more than half of that will be recouped by eliminating numerous tax breaks.”

“Yesterday Trump reportedly told a group of Democrats and Republicans that these tax proposals could result in a 6% annual growth rate for the US economy; a level which is way above even optimistic market forecasts.  That said, if tax reform raises the chances of the US sustaining a 3% growth level it is likely to be seen as a positive factor for the USD.  That said, today’s announcement will only mark the start of a tax overhaul process that could take months to see through.  The ensuing debate by lawmakers is likely to result in a significant watering down of the proposals that are laid out today.”

“For the USD, a key aspect of the plan centres on whether there would be an end to the US practice of taxing corporate profits irrespective of where they are made. Currently companies can defer paying this tax until they bring them back to the US.  This has resulted in huge offshore stockpiles of cash by US companies.  It is thought likely the GOP could propose a one-time tax on these profits potentially at different rates dependent on the liquidity of the investments that it is currently held in.  If such measures are agreed, there could potentially be a surge of demand for the greenback – though in reality it is likely that a lot of these profits are already denominated in USDs.” 

“As it stands Trump has so far failed to score a significant legislative win since he took office in January and this has had a significant impact on sentiment with respect to the USD. At the end of last year the USD had been lifted by optimism regarding the outlook for fiscal reform.  This fast eroded during the course of this year.  A reduction in confidence over the summer months about the potential for a third Fed rate hike this year also weighed on the greenback. From sitting on substantial long USD positions at the end of 2016, the market has switched to holding USD shorts.  In turn, however, this now makes the USD more sensitive to positive news.  Fed Chair Yellen has indicated that the Fed is still prepared to hike rate in December which is USD supportive.  Also the market is not positioned by any legislative success from Trump.”

“Positioning suggests that the USD was ripe for its current bout of short-covering. The fact that Merkel’s hollow victory at the German elections potentially marks the end of a period of political calm in the Eurozone supports this week’s pull back by the USD vs. the EUR.  That said, we are still of the view that the Fed will bow out from hiking rates this year.  In addition, given the divisions within the Republican Party is would still be a huge leap of faith to expect substantial tax reform to be written into US law by the end of this year.  Consequently while we acknowledge that the near-term pull back in EUR/USD could have further to run, we retain our view that EUR/USD could push higher to the 1.22 area on a 6 mth view.  The August low close to the EUR/USD1.1660 area should offer strong support.”