Why The 'Trump Trade' Has Asia In A Panic

At the same time, Katz warns,“Trump's inflationary policies - additional big tax cuts and the tariffs - will compel the Federal Reserve to impose higher interest rates than it now intends. That, in turn, will put downward pressure on the yen.”

These threats, and other imponderables, are already complicating the Bank of Japan's decision at next week's
July 30-31
policy meeting. Mounting market expectations that Governor Kazuo Ueda's team might hike interest rates may indeed get trumped.

Already, Ueda confronts conflicting economic currents. On the one hand, the private sector is showing welcome signs of recovery, as evidenced by the Jibun Bank Flash Japan Composite purchasing managers index climb to 52.6 in July. It marked the sixth straight month of expansion.

Yet BOJ officials detect weakness in consumer spending at a moment when the economy is only barely expanding. Tightening now might also end
Japan's best stock rally
in more than 35 years.

This latter wrinkle explains why BlackRock Inc is so sure the BOJ will avoid acting next week.“We expect an accommodative environment to continue in Japan,” Yuichi Chiguchi, chief investment strategist at the Japan unit of the world's biggest asset manager, tells Bloomberg.

Another risk: a skyrocketing exchange rate could unnerve global investors as the so-called“yen-carry trade” goes awry. Suddenly traders borrowing cheaply in yen might sell investments in higher-yielding assets everywhere, including Shanghai and Seoul.

Currency traders are far more divided than normal about next week's BOJ meeting. A big yen rally this week is“potentially squeezing the yen short positions, given yen-funded carry trading has been a popular strategy over the last few years,” says Charu Chanana, head of FX strategy at Saxo Capital Markets.

Chanana notes that Fed easing bets are“coinciding with expectations that the Bank of Japan may hike rates further at the July meeting. This potential shift in yield differentials favors the yen.”

Economist Takeshi Yamaguchi at Morgan Stanley MUFG Securities says“we think the economic case for a July rate hike is compelling, as more data point to a rise in the underlying inflation trend.”

Meanwhile, Kishida's political fate is getting renewed attention in the days since Biden bowed out of the election.

Within his party, Kishida is under pressure to“pull a Biden” so that the LDP can find a more dynamic successor. Party powerbrokers reckon the weak economy and a series of finance scandals cry out for a new prime minister.

Biden's political recusal robbed Kishida of a top selling point: a strong relationship with the
US leader . Along with his closeness to Biden, Kishida also scored points with trilateral summits with Biden and Yoon.

This detente of sorts with Seoul displeased Xi's Communist Party, which fears the US, Japan and South Korea are building a democratic bulwark against China. Even pulling Philippine President Ferdinand Marcos Jr into the mix at times, too.

Biden's exit complicates Kishida's way forward. In much of his 33 months in office, Kishida struggled to get his support rates into the 30s, never mind the 20s they're stuck in now. Even though Japan's opposition parties are in disarray, the LDP may opt for a new face before September.

Japan is not without leverage should Trump return. For one thing, Kishida initiated a big jump in defense spending, heading off what's sure to be a top Trump priority. For another, Japan is America's top foreign investor.

“Trump wants Japan to keep investing in the United States,” notes David Boling, an analyst at Eurasia Group. At the same time, Boling adds,“the United States needs Japan as an ally to effectively counter China. Advisers to Trump will remind him of Japan's importance.”

Yet“it will be hard for Japan to avoid higher tariffs if Trump returns to office” given that“trade policy is one of Trump's highest priorities and tariffs are in his genetic makeup, it will be hard for Japan to avoid higher tariffs if Trump returns to office,” Boling notes.

Should the yen resume its decline, Trump might be even harder on Tokyo. Jasmine Duan, senior investment strategist at RBC Wealth Management Asia, says markets would be on the lookout for Trump to take actions to make the yen rise.

Bottom line,“we don't think Japan would be the
safest market
in Asia if Trump is re-elected,” Duan notes.

Trump Trade fallout could reverberate far beyond Asia.“For Europe, the prime concern is tariffs,” says Sharon Bell, an analyst at Goldman Sachs.“Trump has pledged to impose a 10% tariff on all US imports. Our economists estimate it could take out one percentage point from the Euro area and 0.5 percentage points from US GDP.”

Each one percentage point drop in sales-weighted gross domestic product could mean a 10% drop in earnings per share, Bell explains.

Adding to the confusion factor is the many different scenarios that investors must entertain ahead of the US election
on November 5.

David Roche, president of Quantum Strategy, thinks that Harris leading the Democrats boosts the odds of a Trump victory. But it also makes it less likely that the Republicans will win both houses of Congress.

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On the other hand, says Charles Myers, founder and CEO of advisory firm Signum Global Policy, Harris could spell trouble for Trump's election hopes. Harris as front-runner for the Democratic nomination makes this“a whole new race,” Myers tells CNBC.

“There's a new candidate with an enormous amount of unity and enthusiasm behind her,” Myers explains. She'll be a key driver of women, young people, Black voters ... I think people will underestimate her,” he added.

Bottom line,“I think that it's a bit too early for the markets to declare victory for Trump, and I think she's going to give him a real run for his money,” Myers says.

Anatole Kaletsky, economist at Gavekal Dragonomics, adds that“whatever one thinks of Kamala Harris, her chances of winning the election are certainly higher than were Biden's. And the remote possibility that the Democrats might agree on another, much better candidate than Harris - while a low-probability
tail risk
- would transform the likely outcome of the race.”

For now, Kaletsky notes,“nobody can quantify the scale of this transformation until new polls are published and the Democrat succession is clarified. My hunch is that Trump will remain ahead for the next few weeks, at least until the traditional start of full-scale campaigning on Labor Day. But I think his probability of winning will fall sharply from last week's 70% or 80%
in the best election models, to something like 55%.”

In theory, Tokyo would prefer a Harris victory, viewing it as the best chance of continuity. One big fear about Trump is that he would renew efforts to shake Tokyo down for $8 billion per year to host US troops (Trump 1.0 had tried unsuccessfully to implement that policy).

Japan also fears that transactional Trump might pursue a“grand bargain” trade deal with Xi that leaves other top Asia economies looking in from the outside.

But whether a Trump Trade emerges, or Harris wins the presidency, all that officials in Tokyo, Beijing, Seoul and Taipei thought they knew about the year ahead is no longer clear or certain.

Follow William Pesek on X at @WilliamPesek

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