President Trump’s assertion on Wednesday (April 12th) that the US dollar was “too high” precipitated a sharp correction in exchange rates and hit Japanese equities. The administration’s propensity to use force in the Middle East is also unnerving investors, as they ponder the US president’s intentions towards North Korea. The softer payroll report for March could have contributed to the dollar sell-off. The very benign CPI data for March (-0.12% m/m, ex-food & energy) may contribute to a weaker dollar too.
There are, of course, deeper reasons for the dollar reversal. Interest rate differentials can only carry a currency for so long. Trade imbalances matter more over the long run. Eventually, the power of interest rate arbitrage to drive a currency higher (in this case the US dollar) will be countered by current account deficits. China’s trade surplus is coming down: the current account has fallen even more quickly. Mr Trump bowed to the facts and decided not to label China a currency manipulator. Japan and Germany may not be let off the hook so lightly. Trade will be the focus of high-level talks between Washington and Tokyo due to start on Tuesday.
Hence, the yen took the brunt of the dollar sell-off, but the euro was not far behind. In Japan’s case, the dollar correction followed a strong current account report on Monday, which showed Japan has a very competitive economy at current exchange rates. The yen was pushed up sharply during the mid-1990s in response to a sharp rise in Japan’s current account. Cutting the discount rate to a then low of 0.5% failed to dent the ‘super yen’. History could be about to repeat itself.
Summary
- Will the yen revisit the highs of 1995 (Y/$79)?
- Sharp rise in current account surplus reflects comparative advantage in robotics/machinery
- Demographics will support case for stronger yen
