A full-blown trade war between China and the United States has not yet broken out and may yet be avoided but there is a whiff of grapeshot in the air. For markets, such an atmosphere does not lend itself easily to an appetite for risk, instead fostering a demand for safe havens. That should spell volatility for the currencies of Australia and Japan. The Australian dollar could struggle if a few opening salvoes between Washington and Beijing turn into a China-US trade war, given the importance of China as an export destination for Australia. No one should underestimate the cross-border economic links between the two nations. The Australian Trade and Investment Commission (ATIC) made the point in December that for the 2017 financial year roughly 66 per cent of all Australian exports of goods and services were sold to East Asia “with almost 30 per cent going to China alone”. “The direction of exports is still [nearly] all about China,” the ATIC wrote. Additionally, within the important raw material export space, the ATIC noted significant rises in the value of Australia’s exports of both thermal coal and iron ore. In both cases the commission attributed those rises in part to demand linked to strong growth in Chinese steel production. More generally, Australia’s reliance on coal and iron ore exports for use in global steelmaking only reinforces the prospect of Australian dollar vulnerability in a situation where, specific China-US trade tensions aside, US President Donald Trump has already announced tariffs on steel and aluminium imports. The subsequent decision to give Australia a temporary exemption from those tariffs is irrelevant. Australia is neither in the top 10 nations who export steel to the US nor in the top five of those who sell aluminium to the US. But if the Australian dollar may be vulnerable in an unfolding scenario of heightened international trade tensions with China-US trade differences at their core, the Japanese yen might be sought after even though, as of Friday, Japan’s steel exports to the US were still subject to Trump’s tariff plans. That might seem an inconsistent view but from a currency market perspective, the Australian dollar would likely be regarded as a risk asset, in the past having been seen by the currency market as a quasi-play on China. In contrast the Japanese yen is usually seen as having the attributes of a safe haven. The yen’s safe haven status is arguably predicated on two factors. Firstly Japan, for all its own economic struggles, is a rich nation with investments all over the world that can be repatriated, in yen, for safekeeping when occasion demands. In that regard it’s worth recalling that in March 2011, after Japan suffered a calamitous earthquake, tsunami and a nuclear meltdown at the Fukushima power plant, the Bank of Japan (BOJ) was joined by other central banks in efforts to stabilise the value of the yen. But their efforts were not directed at stopping Japan’s currency weakening but rather to temper a surge in its value as yen poured back to Japan. Secondly, due to continuing BOJ ultra-accommodative monetary policy settings in the pursuit of domestic inflation, it has long been cheap for currency market participants to fund long plays on other currencies or indeed other assets by being short of Japanese yen. This is particularly prevalent when risk appetite is strong but it also means that when market participants become more risk averse there is potential, in the currency space, for Japanese investors to move back into yen at the same time as the global investing community itself is unwinding risk exposures that rest on a short yen position. The Japanese yen can rise even though BOJ policy is unchanged and, as in the case of Trump’s steel tariffs, the Japanese economy itself stands to lose out. Japanese policymakers, conscious that a stronger yen exerts both a disinflationary impulse on the price of imports and weakens the competitive position of Japan’s exporters, will hardly welcome such a firming of Japan’s currency. But there’s not much Tokyo can do about it. The bottom line is that the higher the trade tensions between China and the US, the more the currency market will seek to pre-position itself for what it collectively sees as the likely currency consequences. So, even though policymakers in Canberra and Tokyo might feel it unjustified, the odds are that US trade salvoes aimed at China, and any Chinese responses, will catch the currencies of Australia and Japan in the crossfire.