Simple tax cuts best for dollar, says CBA

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A standard cut in the corporate tax rate by the Trump administration would be more of a boost for the US economy and the dollar than the controversial border-adjusted tax (BAT) cut that has been floated as an option, says Richard Grace, chief currency strategist at the Commonwealth Bank of Australia, the winner of last week’s three-month currency forecast table.

“Over the next 12 months, we will have more clarity on the US fiscal policy outlook. We believe if the Trump administration delivers a plain-vanilla cut in the US company tax rate to 15%, this will be very stimulatory for the US economy, particularly if income tax cuts and infrastructure spending are also occurring at the same time,” Grace says.

“This stimulatory and inflationary fiscal policy will generate a large lift in the dollar through two channels: via foreigners purchasing US equities; and via US multinational corporations repatriating capital back to the US economy. This will generate a large lift in USD and this is largely behind our 12-month forecasts,” he adds.

Proposed tax changes from House Republicans do differ from that of President Donald Trump. While on the stumps, Trump proposed tax reforms that would reduce the tax rates for companies from 35% to 15%.  He has also proposed a repeal of the individual and corporate alternative minimum taxes, and suggested taxing profits of foreign subsidiaries of US companies in the year they earned. 

“If the Trump administration delivers the border-adjusted cut in the company tax rate, then the initial disruptive effects of the tax on the US economy will certainly cause the Federal Open Market Committee to delay raising interest rates and the dollar will decline. The introduction of a BAT is not our central forecast and we only attach a 30% chance of this occurring,” Grace says.

The US central bank increased its benchmark interest rate 25 basis points on March 15, indicating that the US economy is doing well and that the plan is still in place to hike three times this year.

“We see the Fed lifting the interest rate again this year, with the risk of a third rate hike in 2017. We don’t see any other major central banks making policy changes in 2017 – apart from the European Central Bank concluding and further tapering their quantitative easing programme at the December ECB 2017 meeting,” Grace says.