Despite the largest electoral victory in Japan's post-war history granting Prime Minister Sanae Takaichi a strong mandate to revitalize the economy, investors caution that there is minimal room for additional deficit spending. Any aggressive fiscal expansion could trigger severe repercussions in bond and currency markets, given Japan's substantial existing debt burden.
Takaichi's Liberal Democratic Party secured over two-thirds of the seats in last Sunday's lower house election, enabling her to advance her agenda without needing negotiations with other parties or approval from the upper house. While her win earned praise from U.S. President Trump and capitalized on voter dissatisfaction with high living costs, the proposed expansionary fiscal policies have unsettled financial markets.
On Monday, Tokyo's stock market surged to a record high, driven by expectations that stimulus funds would flow to consumers and Japanese corporations. Meanwhile, Japanese government bonds and the yen, which had been declining for months, stabilized as investors awaited details on how Takaichi plans to manage the budget, especially considering Japan's status as the most indebted developed nation.
The outcome is critical for Japan, as a weak yen exacerbates living costs and inflation, and for global markets, since rising Japanese yields often depress bond prices worldwide. Fred Neumann, chief Asia economist at HSBC in Hong Kong, noted that the policy challenge now is sustainability rather than economic revival. He emphasized that markets will closely monitor any signs of fiscal indiscipline, tolerance for yen weakness, or insufficient monetary policy response to inflation.
The Nikkei and Topix indices both hit all-time highs, rising 3.9% and 2.3% respectively. The yen, which had fallen 6% since Takaichi took office in October, strengthened slightly, while the 10-year government bond yield rose 5.5 basis points to 2.28%.
Analysts point out that investor focus is not on the election outcome itself but on the substance, scale, funding, and coherence of forthcoming economic and fiscal policies. Shoki Omori, chief desk strategist at Mizuho Securities in Tokyo, highlighted that market participants are scrutinizing policy details rather than political results.
Investors have hesitated to resume the so-called "Takaichi trade" selling yen and bonds, partly because analysts expect the Prime Minister to respond more proactively to market pressures, including potential U.S. demands for a stronger yen. Market expectations for a near-term Bank of Japan rate hike have edged up, reflecting political stability that may allow the central bank more flexibility—a contrast to Takaichi's earlier reputation for pressuring the BOJ to delay tightening.
Naohiko Baba, chief Japan economist at Barclays in Tokyo, suggested that while the Takaichi administration might initially pressure the BOJ to maintain current policies, public discontent over cost-push inflation and external pressure could eventually push the government toward tolerating rate hikes to counter yen weakness.
The U.S. has already called on Japan to stabilize its bond market, and the New York Fed's apparent intervention last month to curb dollar-yen volatility signals that the Trump administration may advocate for a stronger yen.
Market trends remain powerful, and a resumption of selling in Japanese bonds or the yen would not require much impetus. Rong Ren Goh, portfolio manager at Eastspring Investments, indicated that the election result may allow markets to revert to previous trends, implying higher long-term JGB yields and a weaker yen.
An early test for Takaichi will be her handling of a pledge to suspend Japan's 8% food consumption tax. Funding this cut, estimated to create an annual revenue shortfall of ¥5 trillion ($32 billion), poses a significant challenge and keeps markets alert to fiscal risks. Chris Scicluna, head of economic research at Daiwa Capital Markets Europe in London, noted that uncertainty over fiscal policy is likely to persist, given unanswered questions about how the government will address the revenue gap.
Investors are advised to consider market risks carefully. This analysis does not constitute personal investment advice and may not account for individual financial circumstances.