BANK OF AMERICA: The dollar is set for a big rebound after a difficult year

  • The dollar has fallen 8% this year against a basket of other G10 currencies.
  • But it’s poised for a rebound in 2018 if the GOP tax plan passes, according to Bank of America Merrill Lynch. Right now, the market is pricing in “almost nothing” on taxes.
  • Tax cuts would lift economic growth, prompting the Federal Reserve to raise rates faster than it expects, the firm’s FX strategists said.

2017 has not been the dollar’s greatest year.

Against a basket of G10 currencies, the greenback has lost 8% this year. Even the prospect of tax cuts hasn’t made the dollar more attractive to currency traders.

“It seems to us that the consensus is that the tax reform will not matter much, which is consistent with what our survey data and the feedback during our recent client meetings suggest,” said Athanasios Vamvakidis, the global head of G10 FX Strategy at Bank America Merrill Lynch, in a note on Friday.

“In contrast, we have been arguing that the US tax reform is a big deal and will support the USD in early 2018.” That the dollar has not gained since the Senate passed its version of the Tax Cuts and Jobs Act last weekend shows “the market seems to be pricing almost nothing,” he added.

Vamvakidis sees traders buying the dollar on tax reform after selling the “rumour,” or the period when uncertainty about its passage weighed on traders. The Senate passed its version of the Tax Cuts and Jobs Act in the wee hours of Saturday morning. It’s now set to resolve the differences between its bill and the House version that passed in mid-November.

The tax-cut boost to the dollar would take three forms, Vamvakidis said. Companies would be encouraged to repatriate funds they have left overseas for tax reasons, and some of these would be converted to dollars and used for capital expenditure. Tax cuts could boost annual gross domestic product growth by 0.3 to 0.4 percentage points over the next two years. And this could force the Federal Reserve to raise interest rates faster than it expects.

As for a specific recommendation, BAML says buying the dollar against the Swiss franc is a great way to position for repatriation.

BAML’s David Woo said in 2005, the last time companies got a tax break on overseas earnings, the franc was the second-worst performing currency against the dollar among G10 currencies given the outflows by foreigners. Switzerland contributed to 10% of total repatriated cash dividends by companies, second to Netherlands, Woo said in a recent note.

‘A difficult year’

“It was a difficult year for people like me and people who try to make a living trading or investing in foreign exchange,” said Daniel Katzive, the head of North America FX strategy at BNP Paribas, at a media briefing on Thursday.

Many investors did not expect the dollar to weaken in an environment where the Federal Reserve raises interest rates thrice, stocks surged, and tax cuts moved closer to becoming law. But as the dollar rose from 2014 through 2016, it got expensive compared to most G10 currencies, Katzive said, especially those with low yields like the Swedish krona and the Norwegian krone.

Like Vamvakidis, Katzive also forecasts a rally in the dollar, although this may only prevail through the middle of 2018.

“We’d be getting closer to the ECB pulling the trigger on rate hikes and other G10 central banks tightening policy,” Katzive said. The “writing will be on the wall for the dollar versus these currencies where it’s very expensive. We think we’ll see a lot of investor hedging of dollar exposure begin to really pick up by the middle of next year.”

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