By David Berman
Is the U.S. dollar about to get a boost? Some observers are growing more confident that the U.S. government is going to give companies a tax holiday in an effort to repatriate big profits that are now parked overseas and help stimulate the economy.
It's done this before, in the 2005 Homeland Investment Act, and the results were mixed: A total of $360 billion came back to U.S. shores over the course of the 12-month tax holiday, but most of the money flowed into the pockets of investors in the form of dividends and share buybacks, rather than into job-creating schemes.
Another tax holiday could yield similar results – and expectations are rising that President Barack Obama could introduce such a measure in his much-anticipated speech to Congress on Thursday. However, the amount of money repatriated this time around could be nearly double the previous amount, and the impact on the U.S. dollar CAD/USD-I could be profound, even if the job gains are slim.
Adam Cole, global head of foreign exchange strategy at RBC Dominion Securities, believes that the total amount of U.S. profits overseas is at a record-breaking level between $1 trillion and $1.5 trillion. An estimated $700 billion of this amount could make its way home if the U.S. government cuts the tax rate to 5.25 percent from the current punitive 35 percent.
“Having learned from the 2005 experience when many, wrongly, were skeptical that the [Homeland Investment Act] impact in foreign-exchange markets would be material, markets would presumably react much more significantly to ‘news’ that momentum toward HIA II was increasing, anticipating a repatriation-fuelled U.S.-dollar rally,” Cole said in a note originally released in July.
Cole found that the euro, the Swiss franc and the British pound were among the biggest losers in 2005, meaning that they fell the most against the U.S. dollar as technology companies and pharmaceutical firms brought their money home. The Canadian dollar was a big exception. It gained against the U.S. dollar during this tax holiday, most likely because profits parked here were already held in U.S.-dollars.
For investors who aren’t currency traders, there are still potentially big implications from a tax holiday. Commodities, which tend to be priced in U.S. dollars, could decline if the U.S. dollar rises, which wouldn’t be good news for the commodity-heavy S&P/TSX composite index. U.S. companies that derive the majority of their sales from overseas markets could also be hurt by a rising dollar.
Whatever happens though, the impact is likely to be brief. While the U.S. dollar index rose more than 10 percent in 2005 during the tax holiday, the end of the holiday put the dollar back on its previous path: Down.