The Dollar Boon of "repatriation flows" now looks like fool's gold and it remains to be seen if tax-reform will have a meaningful impact on economic growth.
The Pound-to-Dollar rate may win a stay of execution in the New Year if the Trump administration’s tax reform plan turns out to be the dud that some strategists are saying it will be for the greenback.
Of course, the bill’s expected passing on Tuesday and hopes of faster growth next year could keep the Pound-to-Dollar pair under pressure in the short-term, and there are other domestic factors that might serve the same purpose in 2018.
Speculation over “repatriation flows” was previously set to drive strong gains for the Dollar in the months ahead however, this much-vaunted aspect of President Trump’s tax bill is now seen as unlikely to have much of an effect on foreign exchange markets.
“Our original estimate was that half of these legacy unrepatriated profits are already in USD. However, a survey conducted by Brookings Institute found that the largest U.S. multinational corporations already have 95% of their undistributed foreign earnings in USD,” says Richard Grace, chief foreign exchange strategist at Commonwealth Bank of Australia.
The Trump administration in Washington is now widely expected to succeed in passing tax-reform legislation before the year is out, with an announcement coming as soon as the current week.
Above: Pound-to-Dollar rate shown at weekly intervals.
“A wafer-thin majority is going to be enough to get the US Tax Bill onto president Trump’s desk though first, there’s the 10-hour debate to get through. Sometime tonight/tomorrow, there will be jubilation from those who aren’t gnashing their teeth,” says Kit Juckes, chief foreign exchange strategist at Societe Generale.
A final push to get the bill through Congress begins Tuesday when the House of Representatives will vote on whether to approve the unified bill crafted by lawmakers from both upper and lower houses.
The bill will then go to the Senate for approval before, apparently, landing on President Trump’s desk for signing as early as this Wednesday.
“10-year Note yields have ‘jumped’ to 2.39% and TIPS are at 48bp, so you can almost feel the anticipation in FIC-land (not). The reaction is equity markets is more seasonally-apt, with new S&P/Dow highs and a positive mood in much of Asia,” Juckes adds.
Boon or Bane?
For all of the supposed economic benefits expected to come from the administration’s signature policy, the impact on the US currency, and the Pound-to-Dollar rate, is likely to be short-lived if strategists are correct in their most recent estimates.
“Over the eight-year period to the year 2025, a total modest sum of between US$15.7 and US$156.6bn will be converted into USD. Not enough to significantly lift the USD,” says Commonwealth’s Grace.
Expectations of “repatriation flows” are the result of a set of new special tax rates in the reform bill that are designed to incentivise American corporates to bring the estimated $2.8 trillion in foreign profits back to America.
The rub for the currency is that much of this cash is already in Dollars, according to the most recent estimates, and companies have an eight year window over which to bring it home.
“Our conviction of broad USD strength through 1Q has faded as the dollar has failed to respond to obvious rising probability of tax reform, disinflation uncertainty is weighing once more, and the Fed is not signaling acceleration in hikes for 2018 despite building in assumptions of fiscal stimulus,” says Daniel Hui, a strategist at J.P. Morgan.
The eventual impact of the reforms on the US economy is more difficult to predict and will depend, in large part, on whether or not companies choose to invest their tax savings in new revenue-generating projects.
Many have suggested that corporate America is all out of revenue generating ideas because, despite having spent a decade wallering in the largesse of zero-bound interest rates (free money), US economic growth has remained low relative to historical standards.
Business investment hasn’t by any notable measure, it certainly didn’t boom throughout the last decade. But what did increase quite markedly were the dividends paid and share-buybacks carried out by public companies.
“The tax cuts for individuals are more likely to provide a slight short-run bump in economic growth through stronger aggregate demand. Over time, however, the impact from this one-time increase will fade,” says Michael Brown, an economist at Wells Fargo Securities.
“Lower corporate taxes are less likely to provide a short run adrenaline boost to economic growth, but over the long-run this should boost capital formation at the margin, providing some support to labor productivity growth.”
The Pound-to-Dollar rate was quoted 0.11% lower at 1.3364 during noon trading in London Tuesday.
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