Japan braces for Trump's worst as yen takes trade war fire

Asia Times

11-03-2025

Self-awareness isn't often a strong suit among top Bank of Japan officials.
Take Haruhiko Kuroda, arguably the most globally known governor the BOJ has had in its 143-year history. His notoriety stems from a 2013-2023 campaign to end deflation, one that supersized the BOJ's balance sheet to twice the size of Japan's US$4.7 trillion economy.
The resulting plunge in the yen propped up Japan Inc. But now it risks running afoul of the Donald Trump 2.0 presidency in ways complicating Tokyo's 2025. Already, Trump is sending rhetorical shots Japan's way.
That has Kuroda playing defense for his successor at BOJ, Kazuo Ueda. Japan, Kuroda says, must repair 'any misunderstanding' in Washington that it's intentionally weakening the yen to boost exports.
'In fact, the Japanese government has been making huge efforts to prevent the yen from weakening,' Kuroda told local media, pointing to moves to raise interest rates and even intervene in currency markets.
The BOJ, Kuroda stressed, 'is not intentionally guiding the yen lower with monetary policy. If there's any misunderstanding on that point, it needs to be addressed.'
What really must be addressed, though, is Tokyo's understanding of how its policies are going over globally.
Denial doesn't change the fact that the most consistent policy over the last 13 governments has been an undervalued yen. Or that a key reason the BOJ has been holding rates at, or near, zero since 1999 is to protect manufacturers facing increasing competition across Asia.
Spin doesn't change Japan's status as the globe's top creditor nation. Twenty-six years of zero rates gave rise to the so-called 'yen-carry trade.' Over time, investors got into the habit of borrowing cheaply in yen to fund bets on higher-yielding assets everywhere.
This strategy has kept aloft everything from Argentine debt to South African commodities to Indian real estate to the New Zealand dollar to derivatives on New York exchanges to cryptocurrencies.
That's why the yen's recent surge pulled the floor out from under markets around the globe. When the yen zigs sharply, markets have long tended to zag.
As such, the BOJ's move on July 31 last year to raise rates to the highest level since 2008 shook world markets. The same happened in January this year, when the BOJ hiked rates a second time to 0.50%.
Arif Husain, head of fixed income at T Rowe Price, speaks for many when he calls the yen-carry trade the 'San Andreas fault of finance.'
There's growing doubt, though, that the BOJ will keep tapping the monetary brakes as US President Trump layers on ever more tariffs, including threatening to tax Japan's all-important auto industry.
The worry is that higher borrowing costs would exacerbate headwinds caused by Trump's 20% tariffs on China, levies on steel and aluminum and 'reciprocal tariffs' to come.
Yet Japanese inflation is running a bit hotter than the BOJ would like. In January, Japanese inflation jumped 4% year on year, the highest in two years. That's double the BOJ's inflation target. It's also a rate that's exceeding average wage growth.
It's not the environment that Japan wants heading into an escalating trade war. Japan's fourth-quarter growth was weaker than expected. The government's second estimate of gross domestic product (GDP) showed output rose just 0.6% quarter over quarter, down from the initial 0.7%.
'The revisions broadly align with our expectations and confirm the picture of an economy struggling against weak domestic demand,' says Stefan Angrick, head of Japan Moody's Analytics.
It means 'Japan's economy is, at best, treading water,' Angrick says. Fourth-quarter data, he adds, 'masks an economy struggling to get out of first gear. Consumption is going sideways as pay gains have trailed inflation for the better part of three years. Sticky inflation and lackluster pay growth will push real wage gains further into the distance and, with it, an improvement in domestic consumption.'
What's more, Angrick says, 'the deteriorating trade outlook means Japan can't count on exports to save the day. Media reports released Tuesday confirm new US tariffs on steel and aluminum won't spare Japan.'
Takeshi Yamaguchi, chief Japan economist at Morgan Stanley MUFG, says that 'we expect the BoJ to stay on hold at the March 18-19 monetary policy meeting.'
Others were less put off by Japan's GDP showing. To Sonal Desai, chief investment officer at Franklin Templeton Fixed Income, recent data 'supports the view that rates will face heightened upward pressure as monetary policy tightens. The BOJ is likely to hike at least twice more this year, but we are tilting to three.' Desai expected short-term rates to top 1% this year.
There's also an argument that delaying rate hikes might enrage Trump as the yen remains weaker than it might otherwise be. Earlier this month, Trump claimed he warned the leaders of Japan and China they mustn't continue to weaken their currencies.
'You can't do it because it's unfair to us,' Trump complained. 'It's very hard for us to make tractors, Caterpillar here, when Japan, China and other places are killing their currency, meaning driving it down.'
Prime Minister Shigeru Ishiba is no doubt alarmed to hear Trump lump Japan with China as currency manipulators. But his Liberal Democratic Party, and the BOJ under Kuroda's leadership, set the stage for the coming clash with the most mercantilist US leader in at least 125 years.
Kuroda, of course, was hired by then-Prime Minister Shinzo Abe to turbocharge the BOJ's quantitative easing policies. Abe's 2012-2020 premiership sought to end deflation via a sharply weaker exchange rate. Abe chose Kuroda in part because of his handiwork as a senior Ministry of Finance official in the late 1990s and early 2000s.
In 2013, Abe decided the BOJ should take the lead in revitalizing Asia's second-biggest economy. Hiring Kuroda was his big economic gamble _ an aggressive assault on the deflationary forces that had weakened Japan's financial foundations over the previous 15 years.
Kuroda didn't disappoint. He hoarded more than half of all outstanding government securities, a buying binge that all but halted regular bond trading. He gorged on stocks via exchange-traded funds, making the BOJ by far the biggest holder of Nikkei 225 and Topix index shares.
As part of its campaign to drive the yen down 30%, the Kuroda-led BOJ branched out into other asset markets, too. By late 2018, the BOJ's balance sheet surpassed Japan's GDP, a first for a Group of Seven nation.
This milestone is a reminder that for all the focus on the US Federal Reserve's ultraloose policies in Washington after the 2008 global financial crisis, the BOJ has been far more aggressive relative to GDP. And now, as even Kuroda admits, detrimental to Japan's economic development.
In his waning days as BOJ head, Kuroda signaled an about-face in his views on the link between exchange rates and healthy growth. He came to realize, at long last, that the costs of devaluation outweigh the benefits.
'The yen's depreciation might have an increasing negative impact on household income through price rises,' Kuroda told business leaders in late 2022.
Worse than that: the boost from weak exchange rates these last 26 years removed the urgency for disruptive structural reforms.
That's particularly true of Abe, who came to power pledging to loosen labor markets, catalyze innovation, reduce bureaucracy, increase productivity and empower women.
And now, an undervalued yen has Trump lumping Japan in with top American rival China. Tokyo got away with its beggar-thy-neighbor tactics during the Trump 1.0 era from 2017 to 2021 in part because Abe sucked up to Trump, and in part because Trump was linearly focused on China.
The Trump 2.0 White House, though, is targeting US allies even more assertively than supposed foes China, Russia or North Korea. That's been quite a surprise for Canada, France, Germany and other top economies. And it has Japan fearing the worst to come.
On Monday, Japanese Trade Minister Yoji Muto met in Washington with US officials seeking waivers on Trump's tariffs, particularly on autos and steel. To no avail, according to reports.
'The talk of tariffs is, in a lot of ways, worse than the implementation of them,' says David Bahnsen, chief investment officer at the Bahnsen Group. 'The tariff talk, reversal, speculation, and chaos only fosters uncertainty.'
Bahnsen adds that, 'I don't believe the administration knows how the tariff situation will play out, but if I were a betting man, I would say that it will persist long enough to do damage to economic activity for at least a quarter or two, and ultimately result in a deal with different countries that make everyone wonder why we went through all the fuss.'
Sam Stovall, chief investment strategist at CFRA Research, notes that 'how long this period of investor caution persists depends on how quickly it will take the global trade clouds, and the resulting threat of recession, to dissipate.'
Look no further than Super Mario maker Nintendo, whose stock is plunging along with other Japanese video game stocks on worries that Trump's antics will boost prices in the US.
In fact, global investors broadly are 'reducing their positions in Japanese stocks,' including the 'most attractive stocks' that they have so far held on to.
If Kuroda, Ueda or Ishiba think Tokyo is going to escape Trump's wrath, then they're the ones 'misunderstanding' where Japan finds itself as 2025 unfolds.
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