- Wide U.S. Q4 current account deficit still only has a minor bearish impact on the dollar
- Markets wait for Republicans’ corporate tax reform plan as Barron’s says “kill the BAT”
- U.S. oil production not likely to see much of a dent from the recent plunge in oil prices
Wide U.S. Q4 current account deficit still only has a minor bearish impact on the dollar — The market consensus is for today’s Q4 U.S. current account deficit to expand to -$128.1 billion from Q3’s -$113.0 billion, which would be substantially wider than the 8-quarter trend average of -$117 billion. The U.S. current account deficit remains very wide due to (1) generally weak U.S. exports caused by lackluster overseas growth and the strong dollar, and (2) reduced import values caused by low oil prices. The U.S. current account deficit is likely to remain wide in coming quarters due in part to strength in the dollar, which is curbing demand for U.S. exports even as overseas economic growth picks up.
The wide U.S. current account deficit, however, will continue to be only a minor bearish factor for the dollar. There is a net $1.2 billion worth of dollars flowing overseas every calendar day due to the large U.S. current account deficit. To the extent that the recipients of those dollars do not wish to hold them in dollar-denominated assets, those dollars are sold in the $5 trillion/day forex market, putting some downward pressure on the dollar. However, the effects of those dollar sales are relatively minor compared with the bullish impact on the dollar of the Fed’s rate-hike regime and demand for dollars by overseas investors to plow into dollar-denominated financial and business assets.
Markets wait for Republicans’ corporate tax reform plan as Barron’s says “kill the BAT” — The markets continue to wait for the Republican corporate tax reform plan, which has been delayed by the Republicans’ internal battle over Obamacare repeal-and-replace. If the House this Thursday votes in favor of a Obamacare repeal-and-replace bill and clears its plate of Obamacare for the time being, the U.S. stock market may react favorably because House leaders can then presumably move on to their other priority of corporate tax reform, which is of much greater interest for the U.S. financial markets.
Speaker Ryan’s plan for cutting the statutory U.S. corporate tax rate to 20% from the current level of 35% is a key driver of the post-election stock market rally because of the larger amount of after-tax profits that would be available to shareholders. Speaker Ryan will probably not be able to cut the corporate tax rate all the way to 20%, but any cut would be helpful for stocks.
One element of the House corporate tax reform plan that is very likely to pass is a tax measure to encourage U.S. corporations to bring home some of the $2.5 trillion of profits they have stashed overseas. That repatriation is expected to be only a minor bullish factor for the dollar since most of that cash held overseas is already in U.S. dollars. Meanwhile, that repatriation would be bullish for stocks since corporations are likely to use the majority of their repatriated cash to buy back stock, thus boosting stock prices.
The BAT proposal, if approved, could be very bullish for the dollar, perhaps sparking a 10-15% rally in the dollar by some estimates. However, approval of the BAT in its current form seems very unlikely because of opposition from a relatively large group of Republican Senators and from heavy-weight U.S. industries that depend on imports such as the retail, auto and petroleum refining industries. The Trump administration has yet to say whether it supports the border adjustment tax system.
We continue to believe that the BAT is a bad idea and would be bearish for the U.S. stock market, as we have laid out in previous reports. The latest bad press for the BAT proposal came in this past weekend’s Barron’s, which carried the cover-story of “Kill the Border Tax.” The article argues that the BAT would “bring uncertainty and disruption to the U.S. economy” and would be “an experiment in Rube Goldberg economics that the U.S. can do without.”
U.S. oil production not likely to see much of a dent from the recent plunge in oil prices — Oil prices are likely to remain under pressure in coming weeks since U.S. oil production is likely to remain high in coming months. In addition, OPEC is still debating whether to officially extend its production cut agreement beyond its June expiration date. OPEC at its May meeting will likely be forced to extend the production cut agreement, but it remains to be seen whether OPEC members would then adhere to the 2H2017 cuts as well as they have so far in early 2017.
Spot oil prices after the November 30 OPEC production-cut agreement jumped up into the $50-55 range and traded sideways during Dec-February. However, oil prices in early March then fell sharply by about 8% from $53 to the $48-49 area because (1) the world glut of oil inventories is not coming down as OPEC had hoped, and (2) U.S. oil production has steadily risen to partially offset the OPEC production cuts, keeping U.S. oil inventories near record highs.
Oil prices are likely to remain under pressure in coming weeks because U.S. oil production is likely to remain strong, despite the recent oil price drop, because (1) U.S. oil producers have probably already hedged most of their future production at higher prices, and (2) U.S. shale extraction costs have steadily dropped due to improved technology, thus allowing U.S. shale producers to survive lower prices.
In addition, U.S. oil producers can benefit from the fact that the early-March sell-off in oil prices was more heavily weighted in the front-month futures contracts. That means that U.S. shale producers can still sell oil for future delivery at prices above $50 per barrel, as seen in the nearby chart. U.S. shale oil producers with low enough costs can therefore still open a new or existing well and lock in a profit by selling futures contracts at above $50 for the next four years.
