US Dollar Repatriation Flows to Drive the Greenback Higher this Quarter say BofAML

Modified: Monday, 09 April 2018 13:45 BST
Written by: James Skinner

-Repatriation flows to begin during the second quarter.

-$3.5 trillion total US offshore profits, with 40% in US Dollars.

-Lasting effect to come from 0% tax rate on future overseas profits.

The US Dollar could draw a sizeable boost over the next two months, according to strategists at Bank of America Merrill Lynch, as companies begin to repatriate their accumulated offshore earnings back to the US in response to President Donald Trump’s tax reforms.

This is a contrarian call for the bank to make now markets have all but given up on seeing tax reforms drive a recovery of the Dollar.

Previously, in late 2017, “repatriation flows” were all the rage among analysts, many of whom anticipated that a special one time tax discount embedded in the White House tax reform package would entice American companies to send some of their mammoth overseas profits back home.

With a large portion of these offshore profits held in foreign currencies, the idea was that companies would have to exchange them for US Dollars before they could be repatriated, leading the American currency to recover some of the ground it had ceded to many of its rivals in the last year.

However, the first quarter passed by in no time at all and the only thing the US Dollar had to show for it was a 2.5% loss against a basket of comparable currencies.

Above: US Dollar Index shown at daily intervals.

“Although we have not seen large repatriation flows yet and clients we speak to are skeptical (see below), we maintain our view. We expect repatriation flows to start in Q2 and accelerate in the following quarters,” says Athanasios Vamvakidis, head of G10 FX strategy at Bank of America Merrill Lynch.

Estimates of just how much cash America Inc has been hoarding overseas vary wildly although Bank of America puts the number around $3.5 trillion, with around 40% of this amount believed to be held in currencies other than the US Dollar. Companies traditionally stored cash overseas because of US policy that would see American firms paying a 35% tax on foreign profits when those companies had already been taxed on those earnings in the countries where the monies were made.

Now, with the US corporate tax system just having seen its largest overhaul ever, the incentives for companies to repatriate couldn’t be clearer. Not only will they pay a greatly reduced 15% tax rate on the $3.5 trillion of “accumulated profits” from years gone by, they will pay a zero percent tax rate on all future foreign profits that are earned. Vamvakidis and the BAML team see this as potentially having a powerful and long lasting effect on the Dollar that others are yet to recognise.

Above: BAML Research graph taken from client feedback survey.

“Arguing that making repatriation much cheaper on the accumulated profits and completely "free" for new profits will not lead to more repatriation seems strange to us,” Vamvakidis writes, in a recent note. “Reducing the tax rate for earnings abroad to zero would have to make a difference in our view, potentially a large one. The market seems to be ignoring the future repatriation flows, focusing only on the stock of accumulated profits.”

Many critics have claimed the bulk of America Inc offshore profits will already be in US Dollars and so the impact of repatriation flows on currency markets would always be small. But Bank of America’s own proprietary survey of corporate clients suggests around 90% of US companies with profits overseas will repatriate at least some part of their accumulated earnings.

Moreover, the bank found that as much as 40% of these profits are held in currencies other than the US Dollar, with more more than 700 US corporate clients from all industries having taken part in the poll.

Meanwhile, the FX strategy team say markets are almost certainly underestimating what a zero tax rate on future profits can do for the US currency in the future. They argue it could generate a lasting stream of repatriation flows.

“Assuming repatriation flows start as we expect, we see scope for consensus to shift closer to our view. Given the strong USD rally following the 2005 Homeland Investment Act, we may see something similar as markets start appreciating the potential size of repatriation flows, both in the short term-from the stock-and the long term-from the flow,” Vamvakidis concludes.

The US Dollar index was 0.18% lower at 90.01 during noon trading in London Monday and is down 2.48% for the year to date. The Pound-to-Dollar rate rate was up 0.37% to 1.4133 and has risen 2.04% in 2018 while the Euro-to-Dollar rate was up 0.26% at 1.2310 and is up 2.65% for the year to date.

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