After the results of the Japanese elections were announced, the market displayed a textbook reaction: the exchange rate weakened initially, the stock market surged, and the bond market was thrust back into the spotlight.
Yen Declines: Stimulus and Tax Cut Expectations Rise, Traders Watch the 160 Level
Following the news that the ruling party secured a majority of seats, the yen briefly fell by about 0.3%, with the USD/JPY returning to 157.7, the lowest level in over two weeks.
The market is concerned about a "more aggressive fiscal narrative"—including increased spending and tax cut promises—further straining Japan's already substantial debt burden and causing the yen's risk premium to rise in the short term.
Several strategists share the view that if the USD/JPY continues to rise and approaches the sensitive range near previous lows (commonly around 160), verbal intervention may increase; however, actual substantive intervention depends more on the speed of fluctuations and one-sided capital movements.
Japanese Stocks Surge: Policy Certainty and U.S. Market Rebound Boost Risk Appetite
In contrast to the yen's weakness, the Japanese stock market strengthened after opening, with the Nikkei 225 index surpassing 56,000 points in early trading, setting a new intraday high.
The investors' logic is straightforward: on one hand, the election results reduce policy uncertainty, making it easier to form expectations for smoother implementation of economic policies; on the other hand, the prior rebound in U.S. stocks has also provided emotional support for Asia-Pacific risk assets.
On the sector level, funds are more inclined towards directions related to policy orientation and capital expenditure narratives, such as AI, chips, and certain defense concepts.
Resurgence of Bond Market Pressure: The Tug-of-War Between Fiscal Space and Fiscal Discipline
While the stock market is benefiting from "tailwinds," the bond market is assessing the "cost." The market was already concerned about fiscal discipline due to pre-election promises of tax cuts and spending, resulting in a notable rise in long-term Japanese bond yields in late January.
The election results bolster the likelihood of stimulus policies, meaning that upward pressure on the yield curve might resurface, especially in a scenario of weakening yen, and renewed inflation and interest rate expectations, leading to tighter interaction between stocks, currency, and bonds.
Three Things to Focus on Next: Fiscal Narrative, Central Bank Expectations, and Forex Intervention Signals
In the short term, the focus is on three areas:
1) How the new government describes the "strength and pace" of fiscal stimulus;
2) Whether changes in rate hike probabilities reflected in overnight index swaps further impact interest rate differentials and capital flows;
3) Whether the official stance on exchange rate volatility becomes more assertive (particularly when the USD/JPY once again approaches the sensitive range).
