Expectations that Japanese Prime Minister Sanae Takaichi will call an early general election are roiling financial markets, fueling a record-breaking rally in stocks, accelerating the yen's depreciation, and driving bond yields to multi-decade highs. Investors are betting that the Liberal Democratic Party (LDP) could secure a victory at the polls, thereby clearing the path for substantial fiscal stimulus, with this "Takaichi Trade" sweeping across Japanese assets.
According to a Kyodo News report cited by Xinhua News Agency on the 13th, Japanese Prime Minister Sanae Takaichi has decided to dissolve the House of Representatives and call a snap election on the 23rd, the day the Diet convenes. Takaichi reiterated on Wednesday that she is considering holding an emergency election on February 8th.
The Nikkei 225 index surged over 1% on Wednesday, briefly breaching the 54,000-point mark, after gaining more than 3% the previous day to set a new all-time high. The Topix index also extended its gains, rising 0.87%. This will be Takaichi's first electoral test since taking office; her support for loose monetary policy and announcement of a large-scale economic stimulus plan are viewed by markets as positive signals.
Simultaneously, the yen weakened past the 159 per dollar level, hitting its lowest point since July 2024. Philip Wee, Senior FX Strategist at DBS Group Research, suggested that markets may continue to test the tolerance of Japanese policymakers for a weaker yen. The absence of clear guidance on the timing, scale, or triggers for intervention keeps speculative pressure on the yen elevated, and an early election could further undermine coordination between the Ministry of Finance and the Bank of Japan in the currency market.
The bond market witnessed significant selling pressure. The yield on Japan's five-year government bond climbed 1.5 basis points to 1.615% on Wednesday, reaching the highest level since the bond's inception in 2000. Yields on two-year and ten-year bonds also rose, reflecting growing investor concern over fiscal expansion and increased debt supply.
A weak five-year bond auction result highlighted fiscal worries.
Japan's five-year government bond auction on Wednesday showed clearly weaker demand, with the bid-to-cover ratio dropping to 3.08, down from 3.17 in December and below the 12-month average of 3.54, marking the weakest performance since last August. Bond futures extended their decline following the auction result.
Ken Matsumoto, Macro Strategist at Crédit Agricole CIB Asia, noted that this was a relatively weak outcome, likely reflecting market expectations that the LDP will win the election, potentially even securing an absolute majority, making it easier for the Takaichi administration to pursue aggressive fiscal policies. He pointed out that if an election is called, the yield curve could steepen further.
Market fragility also stems from a structural shift in debt supply. Although the Takaichi administration plans to introduce a record initial budget for the new fiscal year starting in April, the Ministry of Finance previously announced it would reduce issuance of super-long-term bonds while increasing sales of two-year and five-year bonds. According to Bloomberg analysis, this will increase net sovereign debt supply by about 8% to approximately 65 trillion yen ($408 billion), the largest increase in over a decade.
Coupled with the Bank of Japan's reduction in bond purchases, this shift is expected to push yields even higher. Takashi Fujiwara, Chief Fund Manager at Resona Asset Management, suggested the auction result might also reflect weaker demand from banks for five-year bonds, as changes in central bank lending conditions have improved their loan-to-deposit ratios.
Persistent yen weakness could pressure the central bank to hike rates sooner.
The yen's continued decline may increase pressure on the Bank of Japan to raise interest rates earlier. Although the central bank raised its policy rate in December to its highest level in three decades, the ongoing yen depreciation could force it to act more quickly.
Former Bank of Japan policy board member Makoto Sakurai stated in an interview that, due to market concerns over Takaichi's fiscal policy stance, the central bank might raise the benchmark rate as early as April. However, overnight index swaps indicate that markets have not fully priced in the first rate hike of the year until July, suggesting room for further repricing if yen weakness persists.
According to a Nikkei report, Takaichi plans to convey her intention for an early election to the LDP leadership on Wednesday, a move seen as an attempt to leverage her high approval ratings to consolidate the party's control over the more powerful House of Representatives. A successful outcome would pave the way for a large-scale fiscal stimulus package later this year, while simultaneously increasing Japan's fiscal premium, putting pressure on the yen and Japanese Government Bonds.
Three election scenarios determine the market's direction.
Deutsche Bank, in a recent report, outlined three potential scenarios based on the election outcome:
The first scenario is an absolute stable majority, where the LDP secures more than 261 seats alone. This is viewed as a market call option, with a strong political foundation expected to boost stock prices and lead to a weaker yen due to fiscal expansion expectations. The second scenario involves regaining a simple majority (233 seats). While a victory, it would be a close call; market uncertainty would temporarily subside, but governance challenges would remain. The third scenario, failing to secure a simple majority, is considered the market's nightmare. This would be interpreted as a substantive failure, with fears of political gridlock likely triggering a stock sell-off and a safe-haven-driven appreciation of the yen.
Investors are closely monitoring Takaichi's latest statements and the LDP's decisions. For capital betting on Japan's political stability, the coming month will be a critical test of conviction. The outcome of this high-stakes gamble will directly impact investor portfolios and reshape the pricing logic of Japanese assets.
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