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Sanae Takaichi’s landslide election victory on Sunday sent Japanese stocks through a succession of record highs this week, but even as paper profits were being totted up some investors in Tokyo were starting to wonder if the so-called “Takaichi trade” was slowly turning into a trap.
The 5 per cent rise in the Nikkei 225 index this week is in contrast to the relative calm in Japan’s currency and bond markets, which had been roiled by concerns about Takaichi’s spending plans leading up to the vote.
For some, the post-election disconnect between equity markets and the rest is a sign that the new prime minister has convinced some investors that her plans will be realised but restrained.
However, others are still working out what a more empowered Takaichi means for markets.
Japanese government bonds and the yen “are calmer than we might have guessed ahead of the election”, said one Tokyo-based trader.
“We should probably think of that as a temporary thing, because the questions are all about how she pays for this. I wouldn’t call this a honeymoon, it’s more calm before a storm.”
Takaichi’s relationship with bond and currency markets has been tense since she unveiled a $135bn fiscal spending plan in November, shortly after becoming prime minister.
When she called a snap election last month to capitalise on her popularity, she promised a two-year suspension of consumption tax on food, a measure that will cost the government an estimated ¥5tn ($32bn). In response, 40-year yields crossed 4 per cent for the first time and the yen weakened.
Her big election win, giving her an impregnable majority in Japan’s lower house of parliament, now offers her a chance to act on her spending pledges.
Darren Tay, head of Asia-Pacific country risk at BMI, said the yen now faced a “Takaichi trap”: the more the new prime minister raises public spending to try to address voter concerns about the cost of living, the more she risks undermining the currency. That would increase inflation via Japan’s reliance on imports, including energy, and could eventually hit stock market performance.
Takaichi has so far relied upon her powerful finance minister Satsuki Katayama to reassure markets, while officials issue verbal warnings about the potential for intervention. The yen is trading at close to 153 against the dollar.
“If it bounces back to 160 . . . the government intervenes in the market,” said Osamu Takashima, a foreign exchange strategist at Citi.
The Bank of Japan risks being caught in the middle of the debate. It is expected to raise rates at least twice in 2026. But some traders question whether it will come under pressure to delay increases to give Takaichi more fiscal room to act. That would make defending the yen more difficult. Any intervention by the Ministry of Finance in those circumstances would amount to a “temporary subsidy for short sellers”, said one trader.
In an effort to avoid deepening her issues with financial markets, Takaichi has said her comments about the yen on the campaign trail were “misunderstood” and at her first press conference after the election said that her consumption tax cuts would not involve new debt being issued.
Some analysts are sceptical. “Given the size of [her] mandate, how can she realistically back out of a promise like that? Unlike other prime ministers, she cannot point to parliamentary resistance,” said Benjamin Shatil, senior economist at JPMorgan.
Nor had the election changed the structural drivers of yen weakness, said Shusuke Yamada, head of Japan foreign exchange and rates strategy at Bank of America, who believes companies and investors will continue to search for returns outside ageing, slow growing Japan.
The yen carry trade — the practice of borrowing yen to buy higher yielding assets — was unlikely to reverse in the near term, Yamada said.
“I ask myself if these flows will reverse just because Takaichi achieved a historic victory and they say they won’t rely on extra JGB issuance? I don’t think so,” he said. “They need to see hard evidence that Japan is a better place to invest long term . . . and that takes years.”
At the root of many concerns over Japan’s finances is its public debt, which amounts on a gross basis to 237 per cent of GDP, according to the IMF. That prompts scrutiny of how investors would react if rates rise and government spending increases.
Nicholas Smith, an analyst at CLSA, said such fears mostly reflected the views of foreign investors in JGBs, who account for just 6.6 per cent of ownership but 71 per cent of futures trading and 46 per cent of cash trading.
Foreign investors don’t “have any skin in the game, and every indication is that they don’t really understand the market”, said Smith, adding that Japan’s net debt is significantly lower than its gross debt position and is expected to continue to fall in the coming years.
Others believe the government should pay more attention to foreign bond traders. “The market may be underestimating the populist pressures Takaichi has unleashed,” said Tay. Arguments that Japan’s debt is largely domestically held — and therefore relatively immune from a big sell-off that would push up yields — “may be giving the government a dangerous sense of insulation from global bond vigilantes”, he said.
Takahide Kiuchi, an economist at the Nomura Research Institute, does not think that debt levels are inherently an issue but said he had “never experienced such a sharp increase in long-term yields” as in the pre-election period.
“The Japanese government should react to the warning signs, otherwise Japan could face a crisis,” Kiuchi said.
Data visualisation by Ray Douglas