U.S.-Japan Trade Deal Could Trigger A Rally

The good news is that forward-looking Japan earnings expectations are likely to be too conservative, in our view. For example, several of the large car companies are now forecasting for U.S. car sales to actually drop by as much as 10% in 2019; and on the exchange rate, these companies are budgeting for the U.S. dollar to depreciate to ¥103–105. These strike us as very conservative benchmark assumptions, and, in our view, chances are high that by late summer and early autumn, Japanese earnings revision momentum will start to inflect positively.

Of course, successful completion of trade negotiations and certainty of “no punitive tariffs” will be the ultimate key trigger. In our view, a U.S.-Japan deal is a virtual certainty, with Japan very capable and willing to buy more U.S. military hardware, aircraft and agricultural products to satisfy White House demands to see concrete steps to reduce the bilateral trade deficit through rising U.S. exports to Japan. In addition, the transactional value of the U.S.-Japan trade negotiations can easily be increased further by stepped-up Japanese investments in the U.S., including possibly a concrete Japan-funded U.S. infrastructure investment fund.

All said, Prime Minister Abe has made it very clear he is willing to cut a deal that makes President Trump look good and—unlike in the U.S.-China relationship—there really are no fundamental disagreements between Japan and the U.S. on, for example, intellectual property protection. In all likelihood, the state visit at the end of May will not just bring President Trump as the foreign dignitary to meet the newly enthroned Reiwa emperor but also usher in a new era of U.S.-Japan bilateral trade and economic relations without fear of tariffs or trade retaliation.

There is one caveat, however. The U.S.-Japan trade deal is highly likely to include an option for the U.S. to “weaponize the dollar—i.e., a clause in the deal will specify that any signs of “currency manipulation” detected by the U.S. Treasury can actually become grounds for commercial and trade retaliation. What this means in practice remains to be seen, but it certainly indicates that U.S. policymakers will have gained a new tool they can use at their discretion (although, for now, nobody knows how, when or if it will ever be used).

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