The CBA thinks the US dollar is going way higher

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The Commonwealth Bank’s FX strategy team remain unabashed US dollar bulls, predicting that the buck will strengthen sharply against the euro, Australian dollar, British pound and Japanese yen despite its recent wobbles.

And it will not only be driven by further rate hikes from the Fed, but also Donald Trump’s ability to negotiate wide-ranging tax reforms, it says.

“Our view is the USD will remain well supported because the Fed is lifting interest rates, while all other major central banks are either easing monetary policy or holding interest rates steady,” says Elias Haddad, senior currency strategist at the bank.

“However, the most important determinant for the USD outlook is what the Trump Administration does regarding the US company tax rate.”

US Dollar Index Daily Chart. Source: Thomson Reuters

He says that if Trump delivers a plain vanilla cut in the US company tax rate from 35% to 15%, it will prove to be very bullish for the US dollar for two reasons.

“It will lift the US equity market, generating capital flows into the US economy and, secondly, it will generate a large repatriation of US multinational profits back into the US economy, strengthening the USD,” Haddad says.

He says the tax platform is unlikely to be implemented before the beginning of the new US fiscal year on 1 October, meaning capital inflow driven strength will be delayed until the final quarter of this year.

So what will equity inflows and profit repatriation back to the US mean for other major currencies?

They’re going significantly lower over the next 12 months, says Haddad, and it will largely be driven by US dollar strength.

The CBA sees EUR/USD declining to 0.9500 by the March quarter of 2018, well below its current trading level of 1.0864. It’s a similar story for the AUD/USD with it expected to fall to 0.6900 over the same period, again well below the .7613 level where it currently sits.

The Japanese yen is also expected to weaken, with the USD/JPY forecast to rise to 124.00 by the end of this year.

Out of all the forecasts offered by the bank, the most punchy is probably it’s call on the British pound. GBP/USD, or cable, is expected to slump to just 1.05 by this time next year, over 20 big figures below where it currently resides at 1.2570.

A very punchy call, indeed.

Given the size and speed of these calls, Haddad says that the greatest risks is that Trump’s tax reforms may underwhelm investors.

“Broad based USD strength may turn out to be more muted and less protracted than we anticipate particularly if Trump delivers a border adjustment tax package,” says Haddad.

“If Trump delivers the House Republicans favoured border adjustment tax (BAT) package, the disruptive effects of the tax package will cause the Fed to delay raising interest rates and the USD will decline.”

Haddad says that the implementation of a border adjustment tax — a value added tax levied on imported goods — may slow US GDP growth, and as a consequence global growth.

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