Japan exchanges interest rate hikes for tariff concessions, even a "mini Mar-a-Lago agreement"? Focus on next week's meeting between the U.S. and Japanese finance ministers

With the US and Japan starting negotiations, the yen exchange rate will become a key topic for the US-Japan finance ministers' discussions. Citigroup believes that if the USD/JPY exchange rate remains above 140, the Bank of Japan may accelerate the tightening of monetary policy under US pressure, which will have a significant impact on the yen exchange rate, the Japanese stock market, and global capital flows.

Finance Ministers to Take Over Exchange Rate Negotiations, G20 Meeting May Be a Key Occasion

According to the Global Times, Japanese Prime Minister Shigeru Ishiba stated on Monday that Japan "does not intend to make significant concessions and will not rush to reach an agreement" in the upcoming tariff negotiations with the US government.

Japan's Minister of Economic Revitalization, Ryōsuke Akizawa, stated that he will visit Washington from April 16 to 18 to meet with US Treasury Secretary Janet Yellen and US Trade Representative Greer to discuss tariff issues. However, he clearly stated that the exchange rate issue would not be a topic of negotiation and should be handled by the finance ministers of both countries. This statement highlights the sensitivity and importance of the exchange rate issue.

According to media reports, Japanese Finance Minister Kato Katsunobu and US Treasury Secretary Yellen may meet at the G20 meeting in Washington, D.C. next week. This meeting could become a turning point for the yen exchange rate issue.

Yen Monetary Policy May Be Forced to Adjust

US Treasury Secretary Yellen has expressed a desire to discuss four key issues in the negotiations: tariffs, non-tariff barriers, monetary policy, and government subsidies.

Citigroup analysts stated in a report on April 14 that increasing imports from the US will become the most important topic, particularly in three areas: defense equipment, energy, and agricultural products. The US may also request Japan to lower agricultural tariffs, open the automotive market, and reduce non-tariff barriers.

In terms of monetary policy, in addition to the intervention policies of the Japanese Ministry of Finance, the discussions will also cover foreign exchange reserve management policies and the monetary policy of the Bank of Japan. It is worth noting that the relationship between Japan's monetary policy and exchange rate policy has always been a sensitive topic in public, but this relationship may be brought to the forefront in the upcoming US-Japan negotiations.

Citigroup believes that although the next interest rate hike by the Bank of Japan may be delayed until March next year from an economic data perspective, from an exchange rate policy perspective, if the USD/JPY remains above 140 yen, the Bank of Japan may tighten its policy in advance in exchange for the US lowering tariffs.

Conflict Between Foreign Exchange Intervention Policy and US Financing Needs

Citigroup believes that the US attitude complicates Japan's unilateral intervention in the foreign exchange market.

On one hand, the US does not want the yen to depreciate; on the other hand, if the US wishes to utilize Japan's foreign exchange reserves as a financing tool to issue 100-year bonds, then Japan's intervention in the market by selling dollars may not align with US interests.

Citigroup believes that discussions may cover a comprehensive monetary policy framework that includes not only the foreign exchange intervention of the Japanese Ministry of Finance but also the monetary policy of the Bank of Japan.

Of course, a simple option is for the Japanese Ministry of Finance to intervene, selling dollars and buying yen. However, this would contradict the spirit of the agreements made by the Group of Seven (G7) and the Group of Twenty (G20) to avoid intervention for the purpose of competitive devaluation Citi believes that extending the maturity of U.S. Treasury bonds held by Japan may be a more realistic option compared to the Bank of Japan intervening in the foreign exchange market. At the same time, the U.S. may welcome Japan and South Korea using their foreign exchange reserves to develop U.S. energy resources, particularly Alaska's natural gas resources.

The Bank of Japan May Be Forced to Tighten Early

Citi warns that under the new agreement, the Bank of Japan may be forced to raise interest rates earlier.

Given the possibility of an economic recession, the market has currently pushed back its forecast for the Bank of Japan's next interest rate hike from June of this year to March of next year. From an economic analysis perspective, this seems reasonable.

However, if the USD/JPY exchange rate remains above 140 yen, the Bank of Japan may continue to advance monetary policy normalization in an effort to reverse the yen's weakness, as a return for the U.S. lowering tariffs. From a monetary policy perspective, there is a risk that new expectations for the Bank of Japan to raise interest rates could be brought forward.

A Small "Mar-a-Lago Agreement"?

Citi believes that another tail risk scenario in U.S.-Japan negotiations is that the U.S. quickly advances a small version of the "Mar-a-Lago Agreement" (a multilateral scheme), reaching agreements first with allies such as Japan and South Korea.

However, Citi believes that enabling the U.S. government to raise long-term funds at lower interest rates through 100-year bonds is key to the "Mar-a-Lago Agreement." The premise of this idea is that the U.S. must first successfully control inflation and that U.S. long-term interest rates decline as the Federal Reserve implements monetary easing policies. Currently, these conditions have not yet been met.

Regarding the foreign exchange reserves in the upcoming comprehensive U.S.-Japan bilateral negotiations, a more realistic solution at present is for the Japanese government (Ministry of Finance) to contribute to the recent decline in U.S. interest rates by extending the maturity of its U.S. Treasury holdings.

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