Traders' Guide to Navigating Japan's Upper House Election

Yahoo

4 days ago

(Bloomberg) -- Investors are bracing for a potential triple dip in Japanese bonds, stocks and the yen after Sunday's upper house election, as polls point to a defeat for Prime Minister Shigeru Ishiba's Liberal Democratic Party.
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A loss of majority for the ruling bloc, which is already in the minority in the lower house, threatens to destabilize economic policy and push up government spending. That could trigger selloffs across assets, strategists and investors say.
The jitters reflect growing worries over Japan's government debt burden as interest rates rise and the central bank loosens its grip on the bond market. While the ruling party plans to distribute cash handouts, the opposition has suggested cutting the sales tax. JGB yields hit historic highs this week amid concerns around how such pledges will be funded.
Japan's trade outlook is also at stake as the Aug. 1 deadline for President Donald Trump's 25% levy on exports fast approaches. Investors worry a defeat for Ishiba could derail bilateral tariff talks, hurting shares of exporters like automakers and possibly pressuring the yen.
US Treasury Secretary Scott Bessent will pay a courtesy call on Prime Minister Ishiba Friday evening. Japan's top tariff negotiator Ryosei Akazawa will host the US delegation at the Osaka Expo on Saturday.
'Weak political leadership is clouding the outlook for Japan's market,' said Nozomi Moriya, Japan equity strategist at UBS AG. 'Global investors are looking for alternatives to the US because of political uncertainties there, so strong government direction is a priority.'
Here's what market players are expecting for each asset class.
Japanese Government Bonds
A loss for the ruling coalition would stoke fears of looser fiscal discipline, likely triggering JGB selloffs, strategists say.
The LDP's plan to raise government spending through cash handouts for low-income households would not require the issuance of more government debt, according to the party.
In contrast, opposition groups, including the Democratic Party for the People and the Constitutional Democratic Party, are proposing cuts to the consumption tax, which is seen as a potential blow to government finances.
'If there's a stronger sense that fiscal expansion is getting out of control' after the election, 'super-long JGBs could face a serious wave of selling, like the one we saw a few years ago under Liz Truss in the UK,' said Mitsushige Akino, president of Ichiyoshi Asset Management.
Yields are already climbing on these concerns, with Japan's 10-year government debt yield touching its highest since 2008 on Tuesday. The surge comes amid a worldwide rise in yields as governments from Germany to the US pledge more spending, especially on defense.
Long-term JGBs are especially vulnerable to a rout due to their high level of foreign ownership, wrote Morgan Stanley MUFG strategists Hiromu Uezato and Koichi Sugisaki in a report. Foreign investors are 'sensitive to the fiscal theme,' they wrote.
But some are gearing up to take advantage of a potential post-election dip in bond prices. 'We are certainly on the lookout for dislocated pricing in the JGB market,' Navin Saigal, head of Asia Pacific fundamental fixed income at BlackRock, told Bloomberg TV this week. 'If that happens, we would be very interested to take a bite of that apple.'
If the LDP maintains its majority, however, hopes of 'a relatively moderate fiscal stimulus' could relieve pressure on ultra-long yields, potentially pushing the 30-year yield down to around 2.9%, Uezato and Sugisaki predict.
Stocks
A depleted LDP could spell trouble for equities, particularly those of carmakers, if it weakens Japan's hand in ongoing tariff talks with the US.
'Investors are worried that trade negotiations will be delayed if the election leads to a change of administration or a new prime minister,' said Maki Sawada, a strategist at Nomura Securities.
Anticipation for a trade truce before Aug. 1 has helped buoy Japanese stocks in recent weeks, with the Topix trading not far off its all-time high. But post-election political instability could dent investors' risk appetite, Sawada said. Stocks of large exporters like autos are particularly sensitive to trade developments and would be hit hardest, she added.
LDP losses would also cast doubt over Ishiba's plans to bolster Japan's defense spending, pressuring shares of weapons makers, which have been major drivers of Japanese equities in the past year.
Any sense of 'weakened political continuity' would weigh on 'sectors that are seen as policy-sensitive (defense, infrastructure, and green tech),' said Ipek Ozkardeskaya, a senior analyst at Swissquote Group Holdings.
That said, gains for opposition parties could boost domestic demand-oriented shares, like retail, as consumption tax cuts would become more likely, brightening the outlook for consumer spending, said Kazuhiro Sasaki, head of research at Phillip Securities Japan. That could help the Nikkei reach a new high, he added.
The Yen
Japan's currency may also fall against the dollar if the ruling bloc performs poorly, as anxiety around government spending could dent faith in Japanese assets. Some see the yen breaking the key psychological level of 150, not seen since Trump's tariff announcements in April, if the coalition loses its majority.
'The yen will sell off and the JGB yields will go up. That's the whole jigsaw puzzle,' said Ashwin Binwani, founder of Alpha Binwani Capital.
But political uncertainty could also spark short-term safe haven demand for the yen, resulting in volatility, said Dilin Wu, a research strategist at Pepperstone Group Limited. 'However, over the medium to long term, rising fiscal deficits and higher bond yields put downward pressure' on the currency, she said.
Political fragmentation could lower market expectations of an interest rate hike by the Bank of Japan in the near future, and that may weaken the yen too, Barclays Securities Strategist Shinichiro Kadota wrote in a note.
The BOJ's stance is 'unlikely to be altered significantly,' though, due to pressure from the US for more rate hikes, 'suggesting limited scope for stronger yen depreciation pressures,' Kadota added.
--With assistance from Momoka Yokoyama, Mia Glass, Naoto Hosoda and Kevin Dharmawan.
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