What Happened to the Yen, And What’s Next?

Traders in Japan’s currency had a bit of shock around the weekend as the currency first weakened over 200 pips against the dollar. Then the USD/JPY crashed down nearly 500 pips, and is back to mid-September lows. This naturally opens the question of whether the rollercoaster is over, and what to expect next.

Volatility in the yen has become relatively common of late, a significant departure from the currency’s signature stability. But this move was particularly notable, as it is the result of political changes in the country. And that implies the direction of the currency could have shifted along with the country’s fiscal policy. , which has significant implications for the USD/JPY forecast as well.

The Set Up for the Fall

Over the weekend, we got the results of the leadership contest from the leading LDP party in the Japanese government, in an unusually tight and contested election. The party has effectively run the country since the end of the second world war, meaning whoever is the leader of the party is a shoo-in for new Prime Minister. Fumio Kishida said he wouldn’t run for reelection due to a drop in the party’s popularity following corruption scandals. But, also, the people were not happy with persistent inflation, which means the election has potential forex implications.

Up until Friday, markets were pretty certain that the LDP would elect Sanae Takaichi to the top job. She’s the Economic Security Minister, and noted for having a dovish stance, wanting to help grow the economy and take a “cautious” approach to new interest rate hikes. She was, basically, an ultra dove.

The Shocking Results

In a nail-biting finish, however, LDP representatives chose defense minister Shigeru Ishiba to become the new PM. It was a surprise move, as Ishiba was seen as a somewhat controversial figure, not the least bit shy about sharing criticisms of his Parliamentary colleagues. However, he’s seen as quite popular among the voting public, suggesting that politicians were taking note of the party’s drop in the polls.

Ishiba is substantially more hawkish, both in his purview as civilian head of the military, and in terms of monetary policy. He immediately announced he would form a Cabinet after being formally invested on Tuesday, and would call general elections “soon”. Technically, he has up to a year to call elections.

What Does it Mean For the Yen?

The shift towards hawkishness in the government won’t have a direct impact on monetary policy, since the BOJ is independent. The head of the central bank, Kazuo Ueda, was recently appointed to an eight-year term, and has more than seven years left. The Prime Minister can’t arbitrarily change leadership at the BOJ.

The impact of an Ishiba administration is likely to be indirect, such as implementing more spending on defense that could keep the BOJ fighting inflation for a longer period. Which the market didn’t change its pricing for rate hikes this year (one more is priced in for December), the results of the election could be the end of any hope of the return of the carry trade that weakened the yen over the last couple of years.

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