US-Japan Trade Talks

The withdrawal of the US from the Trans-Pacific Partnership trade agreement lift it exposed on two fronts. First, the TPP was going to modernize the NAFTA. Without, the US remains locked in protracted negotiations. A breakthrough in talks with Mexico has been reportedly imminent for weeks. Talks with Canada have apparently not progressed very far in recently, and the US insistence on a sunset clause remains a deal-breaker.

Second, is a trade agreement with the world's third-largest economy, Japan. About four months ago, Trump and Abe agreed to establish a new framework to discuss "free, fair, and reciprocal" trade. This new framework kicks off tomorrow with talks in Washington between US Trade Rep Lighthizer and Japan's Economy Minister Motegi. Expectations should be kept to a minimum. The US wants a win, of course, and Japan may simply hope to deter more aggressive protectionism from the US, and hopes to avoid a new tariff on autos.

Lighthizer has expressed his desire for a bilateral accord. The standard US demands include opening up Japan's agriculture sector to more US product, and the US has long wished Japan would buy more US autos. Abe had been initially reluctant to embrace the TPP, but since he did, he has not been fickle. The TPP has gone forward without US participation. Montegi may press Lighthiser to reconsider, but it's extremely doubtful that he will agree. At the same time, Lighthizer is most unlikely to get Japan to defect from the TPP-11 agreement by offering the US better terms. Indeed, some other countries want to join TPP, including South Korea, Thailand, Colombia, and ironically, the UK.

For nearly 40 years, US-Japanese trade tensions have been a recurring theme. Voluntary export restrictions and orderly market agreements, which were acceptable under GATT but not the WTO, were used by the Reagan Administration to address the trade imbalance. The US bilateral goods trade deficit with Japan stood at $46.2 bln in 1985 and $41.1 bln in 1990. In the last four years, the annual shortfall has hovered near $69 bln.

However, the deterioration of the bilateral balance ought not to obscure the fact that Japan has moved auto and auto part production to the US. Japanese brands produce around 3.8 mln vehicles in the US, some of which they export. Still, Japanese brands also import cars and parts into the US. A 20% tariff on Japanese auto and part exports to the US could boost costs by nearly JPY1 trillion (~$9 bln). Japanese carmakers also have integrated their production continentally in North America, and if the US puts 25% tariffs on product from Mexico and Canada, the added costs will double to almost $18 bln.

Japan seeks to avoid these tariffs. There are some things that Japan can offer. For example, under Abe, Japan has already dramatically increased its purchases of military equipment from the United States. It can take a page from the European playbook, which offered to do what it was already doing (buying more US soy, gradually boosting defense spending) or wanted to do (buy more LNG), which seemed sufficient to appease the US. The Trump Administration is hungry for a win that would demonstrate that its hardline negotiating strategy is working. In addition to buying more arms, Japan also has expressed the desire to invest in US infrastructure projects.

The US may boost the chances of success by focusing on space that may not be sufficiently covered by the TPP, like barriers to service trade, for which the US surplus is as chronic as Japan's surplus in goods trade and reimbursement for pharmaceutical products. However, given the public rhetoric, including from the free-trade wing of the Administration like Kudlow, there is borderline hubris that might not have been seen since the triumphalism days after the Berlin Wall fell and the Soviet Union collapsed. The Trump Administration seems emboldened.

Meanwhile, the Japanese yen is the only major currency to have appreciated against the dollar. The 1.5% gain this year contrasts with the 3.4% decline in the euro and 3.7% decline in the Canadian dollar. The Mexican peso is the strongest currency here in 2018, appreciated 6.3% against the US dollar. After falling at the start of the year, the dollar entered a JPY105-JPY108 trading range in Q1 and moved to a JPY108-JPY111 range in Q2. We had suspected the dollar was entering a JPY111-JPY114 trading range in Q3. However, the push above JPY113 in the middle of last month seems to have satisfied the demand, and the greenback has spent the last three of weeks in a narrow JPY110.60-JPY112.15 range.

The positions expressed in this material are a general guide to the views of Brown Brothers Harriman & Co. and its subsidiaries and affiliates (“BBH”), and are intended for informational purposes only. The opinions stated are a reflection of BBH’s best judgment at the time the material was produced, and BBH disclaims any obligation to update or alter these views as a result of new information, future events or otherwise. Furthermore, these positions are not intended to predict or guarantee the future performance of any currencies or markets.

This material should not be construed as research or as investment, legal or tax advice, nor should it be considered information sufficient upon which to base an investment decision. Further, this communication should not be deemed as a recommendation to invest or not to invest in any country or to undertake any specific position or transaction in any currency. Investment decisions reflect a variety of factors, and BBH reserves the right to change its views about individual currencies at any time without obligation to inform third parties.

There are risks associated with foreign currency investing, including but not limited to the use of leverage, which may accelerate the velocity of potential losses. Foreign currencies are subject to rapid price fluctuations due to adverse political, social and economic developments. These risks are greater for currencies in emerging markets than for those in more developed countries. Foreign currency transactions may not be suitable for all investors, depending on their financial sophistication and investment objectives. You should seek the services of an appropriate professional in connection with such matters.

BBH, its partners and employees may own currencies discussed in this communication and/or may make purchases or sales while this communication is in circulation. The information contained herein has been obtained from sources believed to be reliable, but is not necessarily complete in its accuracy and cannot be guaranteed. Sources used are available upon request. Please contact your BBH representative for additional information.

This material is provided by BBH to recipients who are classified as Professional Clients or Eligible Counterparties if in the European Economic Area ("EEA"). This publication is approved for distribution in member states of the EEA by Brown Brothers Harriman Investor Services Limited, authorized and regulated by the Financial Conduct Authority. Unauthorized use or distribution without the prior written permission of BBH is prohibited. BBH is a service mark of Brown Brothers Harriman & Co., registered in the United States and other countries.