Commentary on Political Economy

Monday 29 April 2024



Today’s Points:

An Emperor’s Gift

The yen’s swings (yet again) in early Monday trading were too wild to ignore. In a rare show of strength, the currency gained as much as 3% on the dollar in the morning of the holiday to honor the birthday of Emperor Showa (known as Hirohito before his death in 1989). Although it pared some of the gains, the move raised eyebrows, especially given rife speculation of a possible market intervention. Authorities remain tightlipped — declining to comment on whether they stepped in to prop up the currency. But do these theories have any basis? 

First, this was the largest intraday trading range since December 2022, when the Bank of Japan widened its yield curve control tolerance band. Second, a similar oscillation also happened that September after the last Ministry of Finance intervention. Analysts at Capital Economics say the price action has many hallmarks of direct intervention despite the absence of confirmation:

Whether today’s swing in the yen is indeed the result of an intervention or another ‘rate check,’ it effectively turns the 160 level in the USD/JPY rate into the new ‘line in the sand,’ at which the MOF will aim to limit further yen depreciation. In the short term, there are some factors that work in its favor: With the Japan holiday-shortened week, liquidity... will be lower than normal, meaning that a given amount of intervention is likely to go further.

And indeed, a look at how the yen moved during the chaotic morning does it make it look as though something or someone intervened:

Regardless of how pragmatic propping up the yen after such a poor run may sound, the question is whether it would be wise with only hours to go before Wednesday’s meeting of Federal Reserve policymakers, who are expected to deliver a hawkish hold. With US rate sentiments weighing heavily on the yen, an intervention would be no lasting solution in the event of a hawkish Fed pivot. Capital Economics analysts argue that an intervention would only “buy some time” for a little stability but couldn’t lead to a sustained turnaround unless there was a fallback in US interest rate expectations. 

After the Bank of Japan’s dovish hold last Friday, Governor Kazuo Ueda said the yen's limited impact on inflation does not support an intervention. Although still unconfirmed, it would be surprising if the Ministry of Finance were to direct the central bank to intervene in the markets after such a clear statement. Bannockburn Global’s Marc Chandler adds that to say the MOF intervened in the market after Ueda's comments would be a stretch. Indeed, such extreme incoherence would do grievous damage to policy credibility. The yen's wild swing sent its three-month implied volatility to the highest since December – but it’s way off the level seen when officials acted in the autumn of 2022:

Despite the headache that a weak currency bodes for policymakers, it acts as a boon for exporters. That silver lining, however, would be dreadful news for Japan’s competitors and is prompting speculation of a devaluation by China — a potentially epochal event. A boost in exporters’ competitiveness in a neighboring country is not ideal for Beijing, which is embroiled in a trade war with the West that might well intensify in the event of a second presidential term for Donald Trump.

The strength of the yuan compared to the yen has climbed to levels not seen since 1994, when the yuan was devalued by more than 20%. Whatever edge that decision provided for is likely to unwind. Michael Howell at CrossBorderCapital argues that the yen’s weakness confirms the breakdown of the 2016 Shanghai Accord, which had secretly sought pan-Asian currency stability against the dollar after a poorly communicated Chinese devaluation briefly brought world markets to the brink of crisis: 

We suspect that the yen has been deliberately weaponized against the Chinese yuan — evidence of the whopping 2½-fold increase in China’s real exchange rate against the Japanese yen since 2012. The shadowy yuan 'fix' and the years of struggle to stop capital leaving are China’s key vulnerabilities. Japan may be America’s stalking horse!

No matter how appealing it looks to China, a yuan devaluation may not be entirely plausible. It could add too much trouble to an already fractious relationship with the West. On top of that, analysts at the China Beige Book mention in their recent note that “signals” market commentators are panicking about — from surging commodities inventories to a rising gap between the fix and spot prices of the currency — are being misinterpreted: 

China’s financial system is predicated on yuan stability, because of the currency’s (often underappreciated) soft peg to the dollar. A meaningful currency devaluation is not an action that the People’s Bank of China would enter into lightly, and on top of recent trade tensions could spur a serious geopolitical crisis if it were to occur. Beijing does not wish that outcome, at least not yet.

In the end, China and Japan have big decisions to make. Although they are both facing a dilemma that’s been caused by high US rates, these decisions could see their respective currencies head in opposite directions. And whatever they choose, US rates will determine their overall success.

Richard Abbey

Trump 2.0

America’s political classes, together with Wall Street wonks, are suffering through another spasm of bracing for a second Trump term. While polls are close, there’s a strong belief that he’s ahead in the horse race, and the more likely winner. The consensus, surprisingly strong, is that a second Trump term would be very different from the first, and very consequential. This is so even though it’s also the consensus that a President Trump wouldn’t be able to differ that widely from President Biden on the key issues of monetary and fiscal policy, because there simply isn’t enough room for maneuver. Even on trade policy, one of his signature issues, he wouldn’t represent a change of direction from Biden’s own protectionist policies.

Contingency plans. Photographer: Hannah Beier/Bloomberg

But it’s plain that a second Trump administration would seek to exert much more control over the US government. That’s a prospect investors tend to find discomfiting — particularly after this Wall Street Journal story announced that the Trump team were drawing up plans to limit the Fed’s independence, including the right to consultation on interest rate moves, and the option to fire Chair Jerome Powell before his term expires in 2026.  

The critical question is exactly how far a second Trump administration would go. Oxford Economics suggests two scenarios. Under “Limited Trump,” there is looser fiscal policy thanks to extending personal tax cuts and the federal debt-to-GDP ratio rises 4.5 percentage points by 2033; 25% tariffs on targeted imports such as metals and autos are levied on the EU and China, who retaliate; and immigration is cut by 30%. Under a less likely “full-blown” Trump scenario, there are more tax cuts and higher spending; but massive 60% tariffs on China and 10% on other major trading partners (who retaliate), phased in steadily, eventually help bring down debt-to-GDP; China devalues by 10% against the dollar (in these circumstances it’s hard to see how it couldn’t), and immigration comes down by 50%.  

Either scenario would have effects. Trump 1.0 really did have a massive impact on the share of exports that the US derived from China. Other Asian nations, plus Mexico, were the biggest beneficiaries, as this Capital Economics chart illustrates: 

However, a large part of this may simply have involved China exporting its goods via Mexico as the first round of Trump tariffs in 2018 prompted a big shift toward that country and Southeast Asia:

Whether Mexico and China’s Asian competitors would also benefit from Trump 2.0 depends on whether we get the limited or full-blown version. This is Oxford Economics’ estimate of what happens to world GDP:

So Mexico and Canada might benefit a little from a limited version of Trump protectionism, in which their competitors are targeted, but stand to lose more than anyone bar China in the global slowdown resulting from the all-out trade war of “full-blown Trump.” Financial markets would be relatively lightly affected by limited Trumpism (it’s not so different from Bidenism, after all), but the inflationary impact of higher tariffs would force higher interest rates under the full-blown scenario (unless the president gained the right to stop the Fed from imposing them). In a stagflationary world of higher inflation and lower growth, the relative winners, as they were during the 1970s, would be commodity-exporting countries:

It already feels as though the election stakes are unbearably high. For international investors, the question of just how far a new President Trump would go is possibly even more important. Not surprisingly, then, Evan Solomon, of the Canadian think tank GZero North, refers to a PFT (Preparing  For Trump) industry among US trade partners. Even Canada is keen to show that it can deliver wins for a new president, such as more jobs, or more customers for goods made in swing states like Michigan. And judging by the efforts now being channeled into readying for Trump 2.0 across the world, Solomon is right in this judgment:

Maybe the PFT industry is why Trump supporters say he’s so effective. Before he’s even in power, he already has the upper hand. His threat of over-the-top retaliations has effectively put the US in a stronger negotiating position on trade, security and diplomacy — and he’s not yet in office. His plausible threat to collapse the status quo is his most effective negotiating tool. It may make for less trustworthy alliances, weaker international treaties and a more dangerous, less prosperous world, but it fulfills the number one Trump promise to his supporters: America First.

Make Your Voice Heard

Our friends on Markets Live have a new MLIV Pulse survey, and they would be grateful for your participation. This time, the questions are about the boom in zero-day stock options. So far, interest has centered on major index and exchange-traded fund products, particularly those tied to the S&P 500. Would you support expanding their use to individual shares, or would this be a step too far toward speculation that could derail the market? Do you see ODTE options as too expensive or too risky, or, quite the opposite, a great way to bet on near-term moves? Do short-dated options really have influence on the broader stock market, as some claim? Should their use be restricted to professional investors?

Please share your views; the results will be published at the beginning of next week, and they’ll make interesting reading. 

Survival Tips

A comic offering. My brother-in-law has introduced me to Brian Kiley, who is the most masterful punchline comedian I’ve ever seen. It’s not so much a stand-up routine as 25 minutes of continuous one-liners. And the clip I’m linking to was filmed in a dry bar, so there are no four-letter  words. You can actually watch it with the family. One example:

My grandfather died and I asked my Mom, ‘When I die, will I see Grampy again?’
And she said: ‘Not if  you’re good.’


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