Investors are positioning for a decisive victory by Japan's ruling Liberal Democratic Party, led by Prime Minister Takaichi Sanae, in the upcoming weekend election, leading to increased buying of Japanese stocks and selling of the yen and Japanese government bonds.

Polls indicate the LDP is likely to secure an absolute majority in the lower house, which has reignited the so-called "Takaichi trade" over the past week. Despite declines in global equity markets, Tokyo stocks have advanced against the trend, while the yen has weakened and Japanese bond prices have shown volatility.

One risk for investors betting on a continuation of this trend is a poor showing by the LDP on Sunday, which could lead to the prime minister's departure and negatively impact stocks. Another risk is that Takaichi performs so well that she feels little pressure to implement further stimulus measures, which are themselves a core component of the "Takaichi trade."

Global asset managers, including Schroders and Morgan Asset Management, have stated they are underweight Japanese government bonds, particularly super-long-term bonds. Last month, Takaichi's proposal to reduce the consumption tax raised concerns about Japan's fiscal sustainability, triggering significant selling in ultra-long-term Japanese bonds.

"We maintain a bearish stance on the election's impact because the risk is that if the LDP gains an absolute majority, the government could pursue a high-pressure economy," said Kellie Wood, head of fixed income at Schroders. "Without a credible plan to cut spending or reduce debt that can convince foreign investors, risk premiums will remain elevated, and the long-end of the bond market will stay vulnerable."

Arjun Vij of Morgan Asset Management shares this view, noting that despite more attractive valuations, he is currently avoiding direct purchases of long-term bonds. "Following the election and upcoming bond auctions, if yields strengthen again, we might consider buying some long-term bonds but would hedge the risk by selling 10-year bonds," he said.

The persistent weakness of the yen is already influencing interest rate expectations. Overnight index swap data indicate traders see a more than 70% chance of a Bank of Japan rate hike by April, with a 25-basis-point increase by June fully priced in. Meanwhile, open interest in 10-year Japanese government bond futures has risen as prices have fallen, suggesting growing short positions.

A Bank of Japan policy board member stated on Friday that further increases in the benchmark interest rate are necessary to advance the normalization of monetary policy settings.

Against this backdrop, Vij mentioned he remains underweight in front-end Japanese government bonds, expecting the BoJ's policy guidance to be more hawkish over the medium term than what the market currently anticipates.