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Donald Trump won the 2016 election on a platform that was long on rhetoric but short on detail, resulting in constant speculation about what his victory means for the currency markets.
A strong strain of protectionism ran through most of his speeches, in which he constantly bashed the North American Free Trade Agreement and the Trans-Pacific Partnership. He has already pulled the US out of the latter, and the fate of the former hangs in the balance.
However, while markets reacted favourably to his victory, focusing on his agenda to cut taxes and roll back regulations, it has been far from clear what this means for the US dollar.
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John Hardy, |
John Hardy, head of forex strategy at Saxo Bank, says it can be interpreted as good and bad news for the US currency.
“It could be seen as extremely positive for dollar on the back of tariffs and a tax deal which would help eliminate the trade deficit,” says Hardy. On the other hand, it is clear “Trump is interested in talking the dollar down as part of a plan to reshore manufacturing, and for that he will need to have currency wars“.
Kit Juckes, a macro strategist at Société Générale, acknowledges this apparent contradiction, correctly predicting that the press will wonder how to square economic goals that would be helped by a weaker, not a stronger, dollar with policies that are dollar-friendly.
“But markets are more likely to focus on whether his economic policies buoy corporate earnings and domestic demand,” he says. “And as long as there’s a good chance that the Fed responds with tighter monetary policy, the dollar can rise.”
Among the pro-dollar policies Juckes cites are those designed to direct US corporate cash being held offshore back to the US, an issue that Nomura has looked at in more detail.
Charles St-Arnaud, senior international economist at Nomura, has studied the impact of the last US tax holiday that encouraged a similar repatriation, the Homeland Investment Act of 2005, to look for clues about what we can expect this time around.
St-Arnaud estimates that around $1 trillion of funds could be repatriated to the US in response to Trump’s as-yet unconfirmed and unspecified proposal, with the potential repatriation flow going through the FX market potentially reaching $240 billion.
This is likely to put upward pressure on the dollar, particularly against those currencies in which offshore liquidity is being held, namely the euro, as well as the Canadian dollar, sterling and the Swiss franc.
Factoring in where US firms retain their earnings, St-Arnaud estimates the potential flow in EURUSD to be about $100 billion, $17 billion in USDCAD, $14 billion in GBPUSD, $12 billion in USDCHF and $5 billion in USD/JPY.
Liquidity abroad
St-Arnaud analysed the top 20 US firms – excluding financial corporations and health-care suppliers, which have a skew towards domestic activities – that have the most cash and marketable securities on their balance sheets.
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He found the share of liquidity abroad is high for most firms, with Apple having the most, at 91%, and the average coming in at 60%.
St-Arnaud admits it is impossible to accurately predict what the scale of the impact will be, given Trump has not yet outlined the details of his tax holiday. Particulars such as the length the window will be open for, and what the tax rate will be in the US, will determine how much cash is brought back to the US, and how quickly.
If the window was open for a quarter, USD strengthening against other currencies might be more aggressive, though perhaps a longer window would mean a greater move overall.
A lower tax rate in the US would provide a greater incentive for more cash to be repatriated, also accentuating moves. If the US maintained a lower tax rate, new income generated offshore might also be repatriated, but a less favourable rate would likely mean future earnings would be retained offshore again, meaning dollar strength might fade over time.
