Trade-offs.

by Rebecca Patterson.

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.

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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.