TFP could turn more positive for Japan in the future

The Standard Bank has ever argued that there could be some reasons to expect a stronger yen, not just over the next year, or so, should likely Fed easing and BoJ tightening swing the monetary policy balance, but also over the longer-term as well, such as the next five years. It based this on the idea that the absolutely crucial fundamental for any economy, productivity, or more specifically TFP, could turn more positive for Japan in the future.

This, in turn, is down to a number of positive developments in the economy, such as the rising cost of labour and the significant strength of the stock market. But while extolling the possible virtues of the yen in a long-term context, it is also worth bearing in mind that other countries could see relative productivity strength and this might support their currencies, not just against the yen, but on a more general basis. The US dollar is one such currency.

If we look at the history of the US economy through the lens of productivity, we see that so-called US exceptionalism has been sustained for some time. Usually the market thinks about this ‘exceptionalism’ in terms of GDP growth. The US’s near 5% annualised growth performance in Q3 compared to largely flat outcomes in the likes of the euro zone, UK and Japan is one such example. But GDP is misleading. Productivity is better because it is the key to rising real living standards and data shows how the US has been outperforming for a long time, even when US GDP has been relatively weak.

However, it is future TFP that’s key; not what’s happened in the past when it comes to currencies. With this in mind, a number of factors would seem to hold out hope for the US relative to other countries. First up, the whole artificial intelligence ‘revolution’ seems as if it is being funnelled through the US and hence it may be here where the gains to things like productivity will be the greatest. This is not unusual.

“We often find that these major technological advancements are disproportionately developed in the US and it arguably helps explain why there’s been pretty constant stock market outperformance in the US, especially in the tech-heavy sector. We might also argue that US government policy is aiding advancements more than others, such as ‘blocking’ competition, which the rather protectionist Inflation Reduction Act does, prompting others, such as the EU to try to copy. If it is the case that advancements like AI disproportionately aid the US and help lift TFP relative to others, then this is likely to support the dollar. Of course, we don’t know whether AI will be all it’s cracked up to be, or whether the US will be able to lead in the way that it has with other technologies. We also don’t know whether it might cause a destructive bubble in financial assets, such as the so-called dot-com bubble in the late 1990s when we saw the bursting of the tech bubble deflate the dollar as well. But despite these question marks it still seems to us that AI could be a factor that holds the US dollar up a bit better in the long haul. We have been lifting our long-term forecasts (out into the region of the next five years) for the dollar for a little while now and we could continue to do so”, said the Standard Bank.

However, what might happen in the very long term is not necessarily going to take place now and perhaps not even for very many months. The reason we say this is that overlaying these long-term TFP influences on currencies is the shorter-term policy outlook. And, as much as the US dollar might be in a better long-term place thanks to the benefits of AI, it still faces the daunting prospect of rate cuts from the Fed which should, in all likelihood pull the dollar down for some time; probably through a good part of next year and possibly through 2025 as well.

In other words, even if relative TFP outperformance in the US provides a base for longer-term structural US dollar strength, that won’t obviate the likelihood of a cyclical bout of weakness as the Fed eases.