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Sanae Takaichi’s landslide election victory on Sunday sent Japanese stocks hitting consecutive record highs this week, but even as paper profits were rising, some investors in Tokyo were beginning to wonder whether the so-called “Takaichi trade” was slowly turning into a trap.
The Nikkei 225 index’s 5 percent rise this week contrasts with the relative calm in Japan’s currency and bond markets, which were roiled by concerns about Takaichi’s spending plans before the vote.
For some, the post-election disconnect between equity markets and the rest is a sign that the new prime minister has reassured some investors that his plans will be realized but remain restrained.
However, others are still working out what a more empowered Takachi means for the markets.
Japanese government bonds and the yen “are much cooler than we anticipated before the election,” a Tokyo-based trader said.
“We should probably think of it as a temporary thing, because the question is how she pays for it. I wouldn’t call it a honeymoon, it’s more like the calm before the storm.”
Takachi’s relationship with bond and currency markets has been strained since he unveiled a $135 billion fiscal spending plan in November soon after becoming prime minister.
When he called a snap election last month to capitalize on his popularity, he promised to suspend consumption taxes on food for two years, a measure that would cost the government an estimated ¥5tn ($32bn). In reaction, 40-year yields surpassed 4 percent for the first time and the yen weakened.
His huge election victory, which gave him an unassailable majority in the lower house of Japan’s parliament, now gives him a chance to act on his spending promises.
Darren Tai, head of Asia-Pacific country risk at BMI, said the yen now faces a “Takaichi trap”: the more the new prime minister increases public spending to address voters’ concerns about the cost of living, the more he risks weakening the currency. This could lead to increased inflation due to Japan’s dependence on imports, including energy, and ultimately impact stock market performance.
Takachi has so far relied on his powerful Finance Minister Satsuki Katayama to reassure markets, while officials issued verbal warnings about the possibility of intervention. The yen is trading around 153 against the dollar.
“If it gets back to 160… the government intervenes in the market,” said Osamu Takashima, Citi’s foreign exchange strategist.
The Bank of Japan risks being caught in the middle of the debate. Rates are expected to be raised at least twice in 2026. But some traders question whether Takachi will face pressure to delay the hike to give him more fiscal room to act. This will make it more difficult to defend the yen. Any intervention by the finance ministry in those circumstances would amount to a “temporary subsidy for small sellers”, said one trader.
In an effort to avoid deepening his issues with financial markets, Takaichi has said that his comments about the yen during the campaign were “misunderstood” and in his first press conference after the election he said that his consumption tax cut would not include issuing new debt.
Some analysts are skeptical. “Given the size of (her) mandate, how can she really walk away from such a promise? Unlike other prime ministers, she can’t point to parliamentary resistance,” said Benjamin Shatil, senior economist at JPMorgan.
Nor has the election changed the structural drivers of the yen’s weakness, said Shusuke Yamada, head of Japan foreign exchange and rates strategy at Bank of America, who believes companies and investors will continue to look for returns outside of older, slower-growing Japan.
Yamada said the yen carry trade – the practice of borrowing yen to buy higher-yielding assets – was unlikely to reverse in the near term.
“I ask myself, will this flow reverse just because Takachi has won a historic victory and says he will not count on issuing additional JGBs? I don’t think so,” he said. “They need to see strong evidence that Japan is a better place for long-term investment… and that takes many years.”
At the root of many concerns over Japan’s finances is its public debt, which stands at 237 percent of gross domestic product on a gross basis, according to the IMF. This prompts an examination of how investors will react if rates rise and government spending increases.
Nicholas Smith, an analyst at CLSA, said such fears mostly reflect the views of foreign investors in JGB, who have just 6.6 percent ownership but 71 percent of the futures business and 46 percent of the cash business.
Foreign investors have “no interest in the game, and every indication is that they don’t really understand the market”, Smith said, adding that Japan’s net debt is significantly lower than its gross debt position and is expected to continue to decline in the coming years.
Others believe that the government should pay more attention to foreign bond traders. “The market is probably underestimating the populist pressure exerted by Takaichi,” Tai said. The argument that Japan’s debt is largely domestically held – and therefore relatively immune to big selloffs that would push yields higher – “could give the government a dangerous sense of isolation from global bond watchdogs”, he said.
Takahide Kiuchi, an economist at Nomura Research Institute, doesn’t think debt levels are inherently an issue, but said he has “never experienced such a sharp rise in long-term yields” in the pre-election period.
“The Japanese government must respond to the warning signs, otherwise Japan may face a crisis,” Kiuchi said.
Data Visualization by Ray Douglas
