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e Scenario 4: The current BAT proposal has some obvious issues. Because wages are deductible from taxable income, it essentially taxes domestically produced goods as a share of value added but taxes imports as a share of their total value. This is a clear discrimination that would certainly invite WTO dispute and that could potentially give future non-Republican administrations the excuse to overturn the tax reform. Moreover, the fact that under the current proposal some exporters will potentially pay no taxes does not seem fair to us. Remember, in most countries with a VAT system, there is also a corporate income tax. In this scenario, we assume that after negotiations we get a true VAT that is both WTO compliant as well as being revenue neutral. The USD would do better in this scenario compared to Scenario 3 because the VAT would help level the playing fields between US and foreign produced goods and the US trade balance should improve. How to trade it? We view the recent weakening of the USD and rising inflation breakevens as mutually inconsistent, since we think Scenario 2 is not a viable political outcome. The fact that all other scenarios are associated with a stronger USD and lower to flat inflation breakevens is supportive of our bullish USD view. The market needs more clarity on the details of the fiscal reform proposal to determine the outlook for the USD and rates. It is possible that details may be unveiled as early as the president’s speech to the joint session of Congress on February 28, 2017. We think it could validate our view of a stronger USD. Taking advantage of clean positioning and the decline in implied FX vol lately, we recommend buying a 6w ATM EUR put/USD call (spot reference at 1.0630). A 6-week option will cover also the March Fed meeting and the Dutch election (both on March 15} that can both potentially work in favour of the trade. We think the market is underpricing the risk of a Fed hike in March and better-than- expected results by the Freedom Party in the Dutch election could intensify concerns of a second-round Le Pen win in May. The latter suggests that over the next 2-3 months it may be easier to buy the USD than to pay US rates and easier to sell EUR/USD than to buy USD/JPY. Bankof America <> Merrill Lynch Cause and Effect | 13 February 2017 7 HOUSE_OVERSIGHT_014727