Why tax reform won't boost the US dollar

Thought of the day

by Chief Investment Office 20 Dec 2017

The long-awaited Republican tax package is nearing completion, having passed both the Senate and House of Representatives. That should be positive for equities; our 12-month target range for the S&P 500 is 2,850 to 2,950 with the passage of tax reform, compared with 2,600 to 2,700 if the bill had failed.

But while the US dollar (USD) benefited early in the year from optimism about President Trump’s pro-growth policy agenda, we don’t expect tax reform to provide a lasting boost to the USD versus the EUR.

  • Federal Reserve officials have indicated that they do not expect the tax package to boost inflation significantly. As a result, we do not expect the dollar to benefit from acceleration in the pace of monetary easing.
  • The tax holiday for US companies bringing home overseas profits is unlikely to lead to a surge in demand for USD. While companies have stockpiled around USD 3.1 trillion of earnings overseas, much of this is already in US dollars.
  • The US currency is set to be weighed down by its large current account deficit, especially relative to the Eurozone. The gap in current account positions between the US (–2.6% of GDP) compared to the Eurozone (+3%), is as wide as it was in 2005–6, a period when the US dollar depreciated sharply. Added to this, the Eurozone economy is at an earlier stage of recovery, which should increase demand for its assets.

So we expect the euro to appreciate against the dollar over the coming year. We keep our forecast for EURUSD at 1.18 in three months, 1.22 in six months and 1.25 in 12 months.

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