Japan’s dominant election result has delivered an unusually wide mandate to Prime Minister Sanae Takaichi and her Liberal Democratic Party, creating room to push through an ambitious economic program without the need to negotiate with other parties or to wait for upper house approval. Yet the market response on the first trading day after the vote underlined how financial investors are reserving judgment until they can see concrete plans to finance any new spending and measures to contain currency and bond-market fallout.
The LDP secured more than two-thirds of seats in the lower house, a margin that affords the government a clear legislative runway. The scale of the victory has been described as the largest landslide in postwar history, and it has emboldened the prime minister to pursue policies aimed at addressing the high cost of living that drove voter discontent.
On Monday, Japanese equities rallied sharply on expectations that Takaichi’s agenda will channel stimulus to households and corporate Japan. The Nikkei at one point reached a record peak, rising 3.9%, while the broader Topix index climbed 2.3% as investors anticipated the near-term boost to consumption and company revenues.
Market caution on bonds and currency
Despite the stock market highs, bond and foreign exchange markets remained measured. The yen - which had weakened by about 6% since Ms. Takaichi assumed leadership of the LDP in October - was a touch firmer at 156.35 to the dollar on Monday, while the benchmark 10-year government bond yield rose 5.5 basis points to 2.28%, a level last seen two weeks earlier.
Investors say their restraint reflects uncertainty about the details of Takaichi’s fiscal program and how it will be paid for. The country already carries the heaviest public debt burden among developed economies, and markets have shown sensitivity to any signals of fiscal looseness that could worsen that position or delay monetary policy adjustments.
"The market therefore will look very, very closely at any hints of fiscal slippage, any hints of kind of being more open to FX weakness, any hints that monetary policy might not react enough to any signs of inflation," said Fred Neumann, chief Asia economist at HSBC in Hong Kong, summing up investor priorities. In his view, the central constraint on policy will be market sentiment.
Political capital versus market constraints
Part of the reason markets have not pressed what some commentators call "Takaichi trades" further is the expectation that the new government may, in time, aim to be attentive to market concerns. There is also external pressure to curb volatility, notably from the United States, which has encouraged Japan to calm dislocations in the bond market. The apparent involvement of the New York Federal Reserve in moderating dollar/yen moves last month was taken by some observers as a sign that the U.S. would back efforts to strengthen the yen.
Analysts note that political stability may actually increase the likelihood of policy moves that are market-sensitive. "Market participants are focused less on the election result itself than on the substance, scale, funding, and consistency of the economic and fiscal policies," said Shoki Omori, chief desk strategist at Mizuho Securities in Tokyo.
Naohiko Baba, chief Japan economist at Barclays in Tokyo, suggested the new administration might transiently press the Bank of Japan to maintain existing monetary settings by claiming public support from the election. At the same time, he warned that messaging which signals reluctance to tolerate currency strength could readily produce further depreciation of the yen. He added that public frustration with rising living costs driven by a weak currency, coupled with U.S. pressure, is likely to nudge policymakers back toward a posture that would allow rate increases to counter yen weakness.
Trends and momentum in bonds and the currency
Momentum has been a persistent force for years in the direction of lower yen value and higher bond yields, and that underlying trend means markets could re-engage existing moves now that the election has cleared political uncertainty. Rong Ren Goh, a portfolio manager at Eastspring Investments, observed that both Japanese government bond yields and the yen had been consolidating into the vote and that the result should enable markets to resume prior trends. The implication, he said, is for higher yields on long-dated debt and a gradual further decline in the yen.
At the same time, analysts caution that it would not take much to reverse investor positioning. The path of both bonds and the currency is contingent on how the government articulates its fiscal plans and on how responsive monetary authorities are to inflation signals tied to currency moves.
Fiscal commitments under scrutiny - the consumption tax pledge
An immediate focus for market participants will be Takaichi’s campaign pledge to suspend the 8% sales tax on food. The suspension is expected to create an annual revenue shortfall for Tokyo estimated at 5 trillion yen, or roughly $32 billion, and will pose a direct funding challenge for the government.
Analysts said that the sales-tax proposal, and unanswered questions about its financing, are likely to keep investors wary. "Her plans for the cut in the consumption tax leave open big question marks about funding and how she’s going to go about making the arithmetic add up," said Chris Scicluna, head of research at Daiwa Capital Markets Europe in London. The uncertainty surrounding fiscal policy, he added, is expected to persist until more detail is provided.
How the government addresses the revenue gap and communicates its budgetary choices will be pivotal for investor confidence. Markets will be especially sensitive to any signs of fiscal slippage, or to language that suggests the administration is comfortable with further depreciation of the yen, because both developments could exacerbate inflationary pressures and stoke volatility in bond markets.
What markets will watch next
Investors will monitor several signals closely: the scale and funding mechanisms for any fiscal stimulus, commentary and actions from the Bank of Japan in response to inflation and currency moves, and the government’s engagement with international partners pressing for stability in currency and debt markets. The interplay among those elements will determine whether equity gains are sustained and whether bonds and the yen resume the directional moves they have shown in recent months.
For now, the immediate market response has been mixed. Equities celebrated the prospect of consumer-facing stimulus, while fixed income and foreign exchange markets have waited for the arithmetic of financing and for signs about how monetary policy might adapt. The choices the new government makes on those questions will set the boundaries of what the political mandate can deliver without provoking market pushback.