TOKYO -- As the dollar gives up some of its recent gains against the yen, some investors are watching for a possible repeat of the Japanese currency's appreciation in the 1990s, when trade friction outweighed monetary policy differences.
The yen has strengthened by 5 against the dollar since bottoming out in mid-December at just shy of 119 yen. It's still down by more than 10 since the November presidential election, when it stood at around 101, amid expectations of U.S. economic stimulus.
The impact of U.S. President Donald Trump's election appeared in currency markets in the form of a widening gap between Japanese and U.S. interest rates. Stimulus hopes combined with concerns about America's fiscal health drove U.S. rates sharply higher, encouraging investors to buy dollars in search of higher yields. But the correlation has weakened somewhat in the new year, with the yen rising despite the growing rate spread.
This owes to Trump's protectionist stance. Before his inauguration, Trump took to Twitter to blast major automakers' plans to build factories in Mexico or to ship cars from there to the U.S. Since becoming president, he has announced his intent to renegotiate the North American Free Trade Agreement with Mexico and Canada.
Currency markets have remained susceptible to these developments. Traders are gravitating toward the relatively safe yen as a hedge against the risk that protectionism will drag down the global economy.
The dominant market view holds that the yen-dollar rate will be swayed by catalysts related to the new administration's economic policy and its protectionist tilt. Some worry that a continued tough approach to global trade by Trump will lead to a similar situation as in the early 1990s, which saw yen appreciation even amid a widening interest rate gap that theoretically should have pushed the currency in the other direction.
"Even though the spread between American and Japanese interest rates grew in 1994 as the U.S. entered a monetary tightening phase, currency markets reacted strongly to such factors as U.S.-Japan trade friction, and the yen strengthened against the dollar," said Maoko Ishikawa of JPMorgan Chase.
Japan's economy grew more export-oriented after its economic bubble burst, resulting in a massive trade surplus that put upward pressure on its currency. This was magnified when a U.S. cabinet member said Washington would maintain its aggressive stance in bilateral automotive trade talks even if the dollar softened against the yen.
Whether the Trump administration's protectionist leanings will create a replay of the 90s remains unclear. "Many Japanese manufacturers maintain local production in America, unlike in the 1990s, and Japan's trade surplus with the U.S. has shrunk," noted Yuji Saito of Credit Agricole Corporate & Investment Bank. "From an economic structure point of view, even if the U.S. steps up protectionist policies, that won't simply put upward pressure on the yen."
Even so, currency markets will remain sensitive to tough talk on trade from Washington until concrete policies come out, likely in the latter half of this year.