Nomura Securities' latest report suggests that the market's interpretation of a potential early Japanese election as purely exacerbating "reflation" is a misjudgment. The firm argues that the core policy objective may not be to strengthen short-term inflation but to advance deeper structural reforms.
According to the report, an early election could also grant the Bank of Japan greater policy flexibility. The market currently prices a 39% probability of a BOJ rate hike in April; a victory for Takaichi could provide the central bank with more room for maneuver in setting monetary policy, reducing concerns over a crowded political calendar.
On January 13th, Japanese Prime Minister Takaichi communicated her intention to dissolve the House of Representatives on the 23rd for an early election. Following the news, the market reverted to the "old Takaichi trade" pattern, with Japanese stocks surging to new highs while government bonds and the yen came under simultaneous pressure. Analysis widely suggests that a stronger electoral mandate would solidify Takaichi's expansionary fiscal stance and preference for loose monetary policy, which, while positive for stocks, heightens market concerns over Japan's debt sustainability, triggering sell-offs in bonds and currency markets.
Nomura warns that current speculation surrounding the election will continue to impact markets. If investors persist in betting on the continuation of the "old Takaichi economics," it could drive further yen weakness and a bear-steepening of the bond yield curve. However, investors should be wary of the risk: if the election results ultimately serve as an opportunity for a policy pivot towards structural reform, the current market pricing based on inflation and easing expectations may require significant adjustment.
Nomura's assessment points to a strategic timing for a shift towards structural reform. The current market reaction is built on a mainstream expectation: that an early election aims to consolidate the political foundation to continue the "Takaichi-nomics" reflation path, centered on fiscal stimulus and a weaker yen. Since last October, leading sectors in the Japanese stock market have concentrated on domestic demand areas like banking, real estate, and construction, while export-oriented sectors such as technology, machinery, and automobiles have lagged, seemingly validating this market interpretation of the policy path.
The Nomura report indicates that the primary purpose of an early election is not to secure a mandate to continue "pushing inflation higher," but to win the necessary political capital and time window to drive "difficult reforms."
The report contends that the old "Abenomics"-style stimulus path is nearing its limits. If Takaichi secures a stable, long-term administration through the election, she would be freed from dependence on short-term votes, thereby gaining the confidence to shift the policy focus from "short-term stimulus" to more fundamental "structural reforms," such as deregulation and tax adjustments to encourage investment.
The report states that judging the policy direction requires attention to three election observation points: First, the core focus of the campaign platform: whether it seeks a mandate for reflation policies again, or positions economic security and structural reform as primary issues. Second, whether the LDP can secure a stable majority of seats. Third, the coalition relationship with Komeito. Given the future need to ensure a majority in the Upper House (not involved in this election), maintaining cooperation with Komeito is crucial, but this also carries risks: a strengthened coalition or potential new alliance could cause government policy to tilt back towards the priorities of coalition partners.
Nomura's report details the market impacts of the old versus new versions of "Takaichi-nomics." The market characteristics of the old policy (centered on reflation) manifest as: a distorted steepening in the bond market (long-end rates rising sharply due to inflation expectations and fiscal concerns), outperformance of export-related sectors in the equity rally, and a tendency for yen depreciation. Its policy pillars are significantly increased government spending, continued BOJ easing, and using fiscal stimulus to drive inflation higher.
The new policy (pivoting to structural reform) could present a different market picture: the bond market might experience a bear-flattening or distorted quantitative increase (yields rising across the board but with different shapes), equity gains would be more led by domestic demand-related sectors, and the yen's trend could stabilize or even appreciate. The corresponding policy focus would shift towards: adjusting and optimizing the structure of government expenditure, guiding the BOJ towards a neutral interest rate (accompanied by rate hikes and quantitative tightening), and enhancing long-term growth potential through tax reform, deregulation, and measures to attract foreign investment.
This policy-induced shift would have differentiated impacts across various asset classes and industry sectors. If financial tightening measures are implemented, the banking sector might perform weakly; whereas a pivot to structural reform would generate more focus on sectors benefiting from deregulation and equity market enhancement.
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