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.
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 EUR\USD to be about $100 billion, $17 billion in USD\CAD, $14 billion in GBP\USD, $12 billion in USD\CHF and $5 billion in USD/JPY.
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.
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.
However, given that some of the deposits that will be repatriated will already be held in dollars, a reduced supply of greenbacks outside the US could also affect the basis swap market, increasing the cost for foreign firms of financing themselves in dollars, says St-Arnaud.
Trump’s unrealistic world
Ashraf Laidi, chief executive officer of Intermarket Strategy, argues any protectionist measures Trump pursues will likely be offset by other governments taking reciprocal steps.
“The notion that Trump’s planned protectionist measures – tariffs and border adjustment tax – will be USD-positive is founded on an unrealistic world, where Mexico, China and other US trading partners would just sit back and watch without any retaliatory action,” he says.
The same logic could apply on the tax holiday. The UK has openly flirted with the idea of slashing taxes as part of its strategy for dealing with Brexit, and while that suggestion was not aimed at the US, it would certainly influence corporate thinking if it materialized.
How other countries would respond explicitly to any tax holiday in the US remains to be seen, but it is likely there would be some response if they saw capital flooding out of their markets and into the US.
The impact could also be offset by Trump’s own policies. The furore around the US travel ban affecting seven predominantly Muslim countries has been good for gold and yen, but bad for US dollars, and it remains unclear how long the issue will weigh on the currency.
SocGen’s Juckes says: “I’m not sure serious analysis is possible, and I don’t trust my gut instincts on something as far from the usual state of affairs, but my bias is still that we’ll get back to the Trump economic programme, and the implications for Fed policy, before too long.”
However the situation develops, it serves as a reminder that the conflicting forces being unleashed by Trump’s unorthodox administration makes it impossible to predict the impact of his policies in isolation.
Nomura’s St-Arnaud concedes that in 2005 the dollar barely moved in response to that tax holiday, which he believes is because it offset downward pressure on the dollar that would otherwise have seen it depreciate.
“In an environment when the dollar is strengthening, like we have today, it could accelerate that existing uptrend,” he says.