Macq-ro insights: The US-Japan relationship

Please refer to page 58 for important disclosures and analyst certification, or on our website www.macquarie.com/research/disclosures. GLOBAL Why this issue matters to investors 1) President Trump’s trade policy puts short Yen trades at risk, as the US is expected to press for a stronger Yen 2) Fair trade and the low level of US auto sector exports to Japan look set to become major issues again 3) The bull case for Japanese equities is improving corporate efficiency, which would be accelerated by political support for foreign competition in the domestic service sector. FY3/17’s total shareholder payout is tracking towards 60% Our Japan macro and financial market forecasts appear from page 39 Other Japan-related reports: 17 January 2017 The Global Macro Outlook 5 January 2017 Japan’s debt-deleveraging marathon 26 August 2016 Timing the exit from unconventional monetary policies: The ECB & the BOJ 26 July 2016 Financial Repression for decades Analyst(s) Peter Eadon-Clarke +81 3 3512 7850 peter.eadon-clarke@macquarie.com Nara Song +81 3 3512 7878 nara.song@macquarie.com 8 February 2017 Macquarie Capital Securities (Japan) Limited Macq-ro insights The US-Japan relationship A bilateral trade agreement: Whilst the initial US list of demands is expected to be heavy, below, the gains for Japan from improving its relatively poor service sector labour productivity are so large that a win-win situation is possible. US-Japan trade talks: possible US agenda items THE DEAL: our expectation of the bilateral trade negotiations’ conclusions Pages 2-3 1) The cost sharing burden of the US military bases in Japan 4 2) Fair trade and market access in the Japanese auto sector 5-9 3) The appropriate level of the Yen 10-19 4) Market access into Japan’s domestic service industries 20-25 5) Inward FDI (into Japan) promotion 26-38 Source: Macquarie Research, February 2017 The US-Japan bilateral auto sector trade deficit is equal to 70% of the total trade deficit, and is unlikely to diminish over any reasonable time horizon. We expect the US to insist on more US auto plants. The total bilateral deficit could be reduced substantially through energy exports to Japan, “and there are many high-paying American jobs that would be created in our energy industries as a result” (Navarro & Ross, September 2016, Fig.7). The Yen: Nonetheless, our conclusion is that Japan is about to endure a protracted period of US pressure aiming to increase the value of the Yen versus the US$. President Trump’s trade policies, and the possible consequences 19 Jan. 2017 Fortress America: Buy America! Trade policy is great again 1 Feb. 2017 An activist US trade policy a.k.a. protectionism (PowerPoint) 16 Nov. 2016 Kevin Brady and the BOJ 9 Jan. 2017 Macq-ro insights: EM economies & US policy risk 25 Jan. 2017 Macq-ro insights: Global slump scenarios and the EM economies that concern us the most 26 Jan. 2017 Canada strategy: America First and a divergent Canada 31 Jan. 2017 Autos: Globalization in reverse gear Source: Macquarie Research, February 2017 We believe PM Abe is committed to tackling Japan’s productivity problem. Japan ratified the TPP (Trans-Pacific Partnership) which would have allowed US service-sector MNCs to enter Japan with political support. With President Trump withdrawing the US from the TPP, we believe the US and Japan will negotiate a bilateral EPA (Economic Partnership Agreement) with similar provisions. If 60% of Japan’s employees are in private sector services with an average 20% labour productivity deficit relative to G7 peers, then there is an opportunity to boost GDP by 12%. This growth would create new demands to reabsorb those laid off. To help with the transition, we would hope to see the government introduce labour market reforms. Our recommendations are on pages 20-21. Macquarie Research Macq-ro insights 8 February 2017 2 THE DEAL “America First” is the US claiming, at the margin, an increased share of a smaller whole. Pressure on trade is potentially going to appear in three forms: 1) Renegotiated bilateral trade agreements 2) Tax reform’s border tax adjustment 3) Addressing China – to quote Peter Navarro “China’s one-way free trade” is simply America’s unilateral surrender in an age of Chinese state capitalism Please see the An activist US trade policy, a.k.a. protectionism PowerPoint for an overview of the issues and an assessment of likelihoods. Renegotiated bilateral trade agreements are becoming part of our base case, and hence this note. 2) and 3) above are risk scenarios with high probabilities, 40-50%. A probability above 50% would need to become our base case. Please see the 25 January 2017 Macq-ro insights: Global slump scenarios and the EM economies that concern us the most for a discussion of the implications of a global growth shock, and the relative vulnerability of EM commodity-exporters. Our expectation of the bilateral trade negotiations’ conclusions Of the five ma