How will Japan’s upcoming election impact yen and JGBs? Nomura explains

How will Japan’s upcoming election impact yen and JGBs? Nomura explains

We have to remember that last year the um uh LDP coalition lost the lower house election. They lost a majority there and there’s a a growing expectation according to the uh polls that the LDP coalition could lose a majority in this upper house election on Sunday. Um I think the interesting thing though Sher is that the markets are already moved to an extent and are pricing uh that an outcome of the leading coalition LDP uh losing a small a majority by a small margin. Uh I think that’s largely priced. Uh so the risks are the two sides are really that uh either they lose lose by a very large margin and and then the opposition parties are a lot more powerful and will come into the coalition or they actually surprise and actually keep a majority. That would be the biggest surprise I think and could cause um the uh long end JGB yields to rally quite a bit. Yeah. And depending on the outcome, you know, obviously it will dictate the um outcome of the tariff negotiation with the United States. But Rob, I do want to get your lines around what you see in terms of the correlation between Japan’s exports to the United States and what kind of a tariff impact Japan is likely to face in correlation to US growth story. Walk us through your thinking here. Yeah, I mean there’s there’s two effects there, Sherry. So, you know, in terms of um uh the tariffs, the direct effect um there will be an impact I think particularly on the auto sector in Japan. Um which is where which they’re very concerned about. Um it seems like auto companies in Japan have been cutting prices to try to um keep market share in Japan. So their their margins are probably already under pressure. Um but uh the other part of it as you talk about is going to be whether the US economy holds up and if the US economy weakens uh as well as tariffs then it’s a double whammy. Um so you know from that perspective um our view is that because of the tariff impact uh and because underlying inflation when you take out rice prices um and energy is still below 2%. We still feel the BOJ is going to be cautious on raising rates and we don’t have another rate hike until January next year. But you know just going back to the elections I think the other big risk is if the LDP coalition does very poorly and loses a majority by a big margin and one of the opposition parties has to join the coalition and wants a more expansionary fiscal policy. Uh that is another danger for Japan. What about the likelihood of a consumption tax cut? Because seems to it seems to me that all the parties I mean across the entire political spectrum everybody wants to have that. That’s right. Uh but it’s it’s a bit more nuance, Martin, in terms of some of the parties want a consumption tax only cut for food items only. There’s others like the the Democratic Progressive Party of Japan that wants across the board consumption tax cut. That would be a lot bigger. Um but you know, that outcome um could lead to I mean a much more expansionary fiscal policy ultimately. Uh the other things to think about is uh if the LDP does very badly um Japan may need a new prime pr prime minister as well. So the leadership could change. And then the other third third thing is the trade talks with the US um who are they going to talk to? Exactly. That could also create um delays. Yeah. So look uh I mean there’s more than an even chance they could lose the majority their majority the LTP and Kito right uh over the weekend on on the 20th. If that does happen, uh what should we be expecting in terms of uh price reaction? We’ve got uh let’s bring up the charts again. Uh their 10 is at 157, so it’s backed off some, but it was up at 159 I think just a day or so ago. That’s the highest we’ve seen for their benchmark in probably about what 17 years all the way going back to to 08. And uh their their long paper, 30 40 year paper, that’s up at record high. So LDP uh coalition loses uh their majority. what happens to dollar yen? What happens to their yields? So, if it’s a small loss, I think it’s largely priced already. And I think the the risk would actually be that we see 30-year yields actually come down a bit. Um, and the yen could actually strengthen a bit. Uh, so I think a lot of it there’s been big moves in in the JGB market in particular, Martin. I think the moves in markets are going to be more if it’s a massive loss by the LDP coalition. So a big loss of majority in that case you could see a further sell off. Um but that’s that’s not our base case. That would be one risk. And then the other and you know if that happens we could see the BOJ coming in with reinban operations and actually adjusting their JGB uh purchases and the scale of um declines uh and the yen could actually go through 150 uh in that case and a really big loss. Um but the other extreme that the market is not expecting is they s LDP surprise and they actually hold on to their majority. And if that happens, I think that’s where you could actually get a big rally in um uh buying of JGBs and also the yen starting to appreciate.

Rob Subbaraman of Nomura discusses Japan’s upcoming upper house election and says while an LDP coalition losing the majority has already been priced in by the markets, any big surprises may cause a big move in Japanese bond yields, as well as the yen.