US-Japan trade negotiations: Double-edged sword for the BoJ – Natixis

In view of the analysts at Natixis, stakes are high for global trade with the Trump administration and because Japan has one of the largest trade surpluses with the US, it will feel the pressure to address the US concerns.

Key Quotes

“The question is what will be the least harmful way for Japan.”

“In reality, trade negotiations have limited space to reduce Japan’s surplus with the US. While import tariffs on autos have been kept at 0% since 1978 in Japan, the share of US made automobiles in Japan is minimal (0.3%). To reduce exports to the US, Japanese companies will need to produce more cars in the US (probably shifting production from Mexico rather than from home). Another possibility to reduce the US trade deficits is rice imports but this looks unlikely, as farmers are a powerful lobby supporting Prime Minister Abe’s Liberal Domestic Party.” 

“Against this background, the focus of policy discussions could shift to currencies as the solution may be more of a win-to-win. Here is the reason: Although the Yen has remained at the most depreciated level since the early 1980s on a real effective exchange rate terms, a weaker Yen is neither in the interest of the US nor of Japan. As the Fed normalizes, the JGB yield is expected to rise along with the US Treasury, requiring the BoJ to purchase additional JGBs to meet its 0% target on the 10 year yield. However, this “excess” purchase would put downward pressure on the Yen, fueling inflation and reducing disposable income.”

“To avoid this dilemma, the BoJ could reinterpret the 0% as a floor rather than a target. By allowing the JGB yield to fluctuate along with the global interest rate, this reinterpretation could alleviate the downward pressure on the Yen, supporting Japanese households’ income. This clarification is also much more simple than engineering a concerted forex intervention to weaken the USD, as has been the case in the 1980s. While this solution could ease tensions with the US administration, it risks undermining the reputation of the BoJ as this target on the JGB yield was introduced only recently.”