Market Update 22nd July 2024

Fickle friends

JD Vance was previously only known to me as the author of a book called Hillbilly Elegy, which later became a Netflix film. It’s an autobiographical story about his working-class origins in the Appalachian mountains and how he overcame a difficult childhood to go to Yale. While promoting the book in 2016, he said “I’m a never Trump guy”. Now apparently he might end up as Trump’s Vice President.

Donald Trump and JD both believe one of the key problems facing the US is a strong dollar. JD has even quizzed Jerome Powell on the subject in a Senate committee hearing and appears to believe the strong dollar is at least partly driven by the dollar’s status as the world’s reserve currency, which he would like to end. I have news for JD about this, but that will have to be a different Innovation. Let’s see if he can get himself elected first.

Why do they think this? The dollar became the world reserve currency as part of Bretton Woods towards the end of World War Two. This created global demand for dollars. The stronger dollar encourages imports and makes exports from the US more expensive. The US runs a trade deficit with most obviously China, who then reinvests its surplus back into the US – both into equities and US Treasuries.

This is one reason the US equity market is so strong, but it is also one reason the US has significantly de-industrialised. Trump and JD want the US to start making things and exporting them again, and a weaker dollar would help.

In November last year I wrote about the Japanese yen and how cheap it looked vs the strong dollar. It was Y149 at the time – historically low. Despite several interventions by the Japanese central bank, including raising interest rates for the first time since 2006. It has continued to fall and is Y157 as I write, having been over Y160 earlier this month. Rhetoric from Trump and Vance is one reason it has been rising from its lows (or more specifically the dollar has been falling). The US election hasn’t happened yet.

As for me being completely wrong about the direction of the yen, all I would say is one feature of markets this year has been momentum. All these trades which looked stretched at the end of last year – credit spreads, growth vs value, the rest of the world vs the US, small cap vs large cap valuations – have all essentially carried on becoming more stretched. The US small cap index has had a huge rally in July but is still lagging large caps year to date.

It is important to look at the make up of the rally in Japan. Japan has historically been a significantly export led economy running a trade surplus with the rest of the world. More recently it has fluctuated between a surplus and a deficit. A weak yen has historically tended to help the equity market and especially exporters, but they have not been part of this rally.

A key sector leading the Japanese market at the moment is banks. They have benefitted from rising rates and reasonable economic growth globally. The weak yen does benefit them, for example with loans to foreign borrowers but they should be less sensitive to this than a goods exporter. Japanese banks are particularly diversified. As well as savings and loans, they do wealth management, advisory services, leasing and other services, which has helped them grow profits even in Japan’s difficult economic climate.  They are generally well funded.

Japanese interest rates are likely to continue rising, even if the numbers are still small and this will help bank earnings even further. Rising rates transfer wealth from borrowers to lenders – in Japan’s case this means from the government to the banks.

The point about all this is that Japan’s weak yen isn’t just their problem anymore. Trump has decided it is a problem for the US as well. The BoJ has been finding out the hard way that you can’t always get your currency to go up just because you want it to, but literally anyone can make it go down. One obvious way to get the dollar down is to reduce interest rates and Trump is already putting pressure on the Fed.

This would have the happy effect of steepening the yield curve – already being known as the “Trump trade”. Our colleagues on the “other” blog were warning about the perils of predicting elections as recently as last Friday. Not only is the market apparently confident about the result, they have given it a name and made a start. Now it turns out we don’t even know exactly who is going to be on the ballot.

Robert Fullerton – Senior Research Analyst

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