Markets had a strong reaction after the election in Japan over the weekend, with the USDJPY moving above the 150 handle for the first time in months. More importantly, it may signal that the yen will weaken in the coming months, possibly reigniting the carry trade. Either way, economists are closely monitoring Japan to see if there will be a significant shift in the markets.
Over the weekend, the ruling party in Japan, the LDP, elected a new President, Sanae Takaichi. The leader of the largest party in the Parliament is usually the Prime Minister, but it will take around 10 days for the formal vote among legislators to replace Shigeru Ishiba. However, aside from some minor changes, the new government will likely be supported by the same parties. What changes is the direction of policy, and for traders, that means monetary and fiscal policy.
How Takaichi Will Affect the Yen
Takaichi, the first woman to get the top job in Japan’s government, was the second favorite during the last election in which Ishiba won. Prime Ministers in Japan tend to have short tenures, with the average of around 2.5 years. She has been characterized as a hard-line conservative, but is also in favor of loose monetary policy and increased government spending. That is in contrast with the more fiscally conservative Ishiba government. This has presided over a period of high inflation and the BOJ struggling to raise rates.
In the wake of Isha’s resignation, Japan’s equity markets soared ahead from the prospect of Takaichi winning the election. Since stock markets typically move in opposition to the currency, the strong performance in the Nikkei 225 is relevant to currency traders. Takaichi is expected to shift the country to a more expansionist fiscal policy, which typically raises stock prices. In a global economy where investors are struggling to find value. they are piling into Japanese equities to the point that the Nikkei is rising faster than gold.
Balancing Out the Forces
Typically, this means the currency becomes stronger as investors must buy yen to invest in the Japanese stock market. That has been the case with Europe, for example. But, unlike the ECB, which was cutting rates, the BOJ was on a tightening cycle after fighting deflation for decades. The stock market can continue to rise into higher interest rates, particularly if those rates are really, really low. That’s the case in Japan, where the reference rate is just 0.5%.
Markets were pricing in around a 50% chance of a BOJ rate cut at the end of the year. However, those expectations have been reduced to just 25% in the wake of the election. The BOJ is an independent institution, but it responds in tandem with the government’s fiscal policy. Takaichi’s policies are expected to prevent the BOJ from risking a rate hike, or at least slow the pace down. Those lower rates mean that the yen has underperformed, despite rising yields in Government debt at the long end of the curve.
What Does Takaichi’s Election Mean for the Yen?
The big question for many traders is whether the carry trade will get restarted if Japan keeps rates low. But that also requires other interest rates to remain high. For now, the Fed is in an easing mode, which makes carry trading less appealing. But the ECB is projected to keep rates unchanged, which could allow for some carry trade pressure.
Overall, Takaichi’s election is likely to leave the yen a little weaker, but it will depend on the details of her economic plan. During the campaign, she emphasized fiscal easing as a distinction from the current unpopular policies. However, that might be adjusted slightly when actually governing.