Rebecca Patterson is a globally recognized macro researcher and investor who has more than 25 years’ experience working in the US, Europe and Asia. An area of focus for Rebecca has been currency markets. She spent her first decade at JPMorgan as a currency analyst, later serving on the New York Federal Reserve’s Foreign Exchange Committee and teaching a course on foreign exchange to the New York Fed’s annual central bank conference.
This is her second column for us. The first one — “China Stuck” — is well worth reading if you have not already done so.
In the last several days, Japan spent nearly $60 billion to strengthen its currency, the yen, by 2% against the dollar. Separately, former US President Donald Trump’s advisors suggested that a second Trump term would include a policy of weakening the dollar, a potentially abrupt change from the last several decade’s strong, or at least stable, dollar policy.
Currencies are powerful tools. Changes in a country’s exchange rate can support or dampen growth and inflation that in turn helps or hurts consumers and businesses. Currency trends can shape the behavior of overseas’ peers and in recent years, have served as geo-economic weapons. They impact company profits which in turn help drive equity market trends.
This ability to shape macro conditions leads politicians around the world, most recently from Japan and the US, to focus on foreign exchange as a means not just to economic ends but political ends as well. The challenge is successfully navigating the trade-offs that can come with hands-on currency policy.
Japan provides a timely illustration of these trade-offs. The country receives global praise for finally escaping decades of effectively zero inflation that had weighed on consumption and led to eight years of negative policy interest rates. The improved economic backdrop, along with corporate reforms and attractive valuations, has made the country’s stock market a global standout. Year-to-date, the Nikkei is up more than 14% in local currency terms. (For a dollar-based investor who did not hedge the currency risk, that return is still nearly 5.3%, more than double the return of the Dow Jones Industrial Average.)
A much weaker yen – the dollar/yen exchange rate reached a 34-year high in the last week of April - helped Japan achieve these goals. The cheaper currency made exports more competitive and indirectly contributed to higher wages. However, the yen-fueled economic and market wins have come at a price, both to consumers and some businesses.
For Japanese firms, the biggest challenge isn’t the higher input costs, but rather the speed of the yen decline. Many multinational companies hedge their currency risk to reduce volatility in the value of foreign earnings. When currency trends are gradual, companies can adjust hedges easily. But when currency moves are explosive (the yen dropped by around 8% just in the first four months of 2024), companies often find themselves offsides - more exposed and more uncertain about how to plan.
While Japanese Prime Minister Fumio Kishida is no doubt aware of these corporate challenges, he is likely more focused on consumers. Japanese wages have increased in recent months, but similar to the US, consumers have focused more on the rising cost of daily life, notably food. Not surprisingly, voters are voicing their displeasure. While not the only driving factor, inflation is cited as a key reason why Kishida’s cabinet has its highest disapproval rating, at 69%, since he was inaugurated in 2021.
The government’s available tools to push prices lower and cheer voters are limited. Raising interest rates could slow inflation and help strengthen the yen by making the currency’s “yield” relatively more attractive. But such action could also threaten the ongoing economic recovery. It would also increase interest payments on Japan’s massive government debt (roughly 260% of GDP). That would mean Kishida would have less room to spend on other priorities that voters care about.
That’s where the yen comes in. The government last week conducted two rounds of market intervention in an effort to strengthen the yen. Available data suggest that as much as $60 billion in central bank dollar reserves were sold in the process.
Such intervention is unlikely to alter the yen’s trend longer-term as long as the US dollar continues to be broadly strong, since the dollar dominates global trade and currency transactions. (Think of the US as the price-setter and other countries as price-takers in global currency markets.) But without the ability to raise interest rates quickly or take actions to force faster wage growth or lower goods prices, intervention may be the best of Kishida’s options. It’s at least a public, high-profile step he can take to show he’s fighting back.
What Japan really needs is a US soft landing, where lower US inflation would allow the Federal Reserve to cut interest rates, making Japanese yields relatively more attractive versus US peers. It’s premature to say if that scenario will emerge this year. But there is another catalyst that could pull the dollar lower and potentially stop the yen-weakening trend: a victory for Donald Trump in November.
According to an April 15 article in Politico, economic advisers supporting Trump, including former US Trade Representative Robert Lighthizer, are actively discussing how to weaken the dollar if he gets re-elected. The economic goal would be to make US exporters more competitive and imported goods more expensive. In isolation this should help US manufacturers which politically, could reinforce support from a key set of voters.
What Trump’s team, and frankly all politicians, say on campaign trails does not guarantee actual policy. It’s also unclear how Trump would execute such a policy; the specific actions taken to pull the dollar lower would significantly shape the trade-offs he would face economically and politically.
In addition, multiple forces shape economic trends. While a weaker dollar by itself might reduce the trade deficit and help exporters, it could be amplified - or completely offset - by other policies and economic variables at the time.
Even with those caveats in mind, it’s still worth considering some of the potential trade-offs that the US might face. Inflation may well top the list. Currently, consensus forecasts on Bloomberg suggest US consumer prices will end 2024 at 3.1%, with core PCE (the Fed’s favored inflation measure) still well above the 2% target, at 2.6%.
A shift to a weaker dollar policy would create an additional inflationary impulse that would make it even harder for the Fed to reduce interest rates. Such an environment of “higher for longer” rates would likely constrict the US housing market and add pressure on companies and households needing to service and refinance debt. Higher interest rates would also increase the challenge for the new administration in that government debt interest payments would rise – similar to Japan’s dilemma, fiscal room for other spending priorities would be more limited.
Politicians are incentivized to use whatever tools they have to get elected and stay in office, including currency policy. It’s important to appreciate that what at first might seem like an easy path to voter-friendly political outcomes often comes with material trade-offs and potentially heavy costs.