Mizuho Securities recently published a report analyzing Japan's general election, offering an outlook on short and medium-term market dynamics following the event. The Liberal Democratic Party (LDP) secured 316 out of 465 seats in the House of Representatives election held on February 8th. This result sets a new post-war record for seats won by a single party in Japan and gives the LDP a standalone two-thirds majority in the lower house. This majority allows the party to re-submit bills rejected by the House of Councillors for another vote, where they could be passed. The ruling coalition, which includes the Japan Innovation Party, now collectively holds 352 seats in the House of Representatives. Meanwhile, the main opposition centrist reform alliance won only 49 seats. The former Constitutional Democratic Party suffered a historic defeat, with many of its candidates losing in single-seat districts. The Democratic Party for the People saw a slight increase in seats, while the ruling Tsubasa no To party significantly increased its representation.

Regarding the LDP's pledged two-year exemption from consumption tax on food and beverages, Prime Minister Takaichi stated she believes the measure is "justified and reasonable." She also confirmed that special deficit-covering bonds would not be issued to fund this policy. After deliberation by a newly established national committee, she will promptly submit the relevant legislative draft to the Diet. Prime Minister Takaichi also identified the implementation of a refundable tax credit system as a "top priority." She explained that this aims to address the regressivity of social security premiums, with the consumption tax cut serving as a relief measure until preparations are complete. Even with an accelerated design process, these preparations may still require "two to three years." Takaichi praised the current cabinet as an "excellent team that is dutiful and has achieved significant results," indicating no immediate plans for a reshuffle. However, she expressed willingness to create an additional cabinet position specifically for the junior coalition partner, the Japan Innovation Party.

Given that opposition parties almost unanimously called for consumption tax cuts, the LDP minimized controversy on the issue by proposing a time-limited exemption specifically for food and beverages. Prime Minister Takaichi remained largely silent on the matter as the election approached, avoiding market volatility and criticism from opponents. The LDP's overwhelming victory is largely attributed to the highly popular Takaichi personalizing the election, effectively staking her political career on the campaign.

**Potential Short and Medium-Term Market Reactions** While current information is limited, making predictions difficult, the report outlines views on potential short and medium-term market trends.

**Short-Term Trends** Although some polls had signaled the possibility, the ruling coalition's historic victory was not entirely anticipated, and markets may not have fully priced in the scale of the win due to inherent election uncertainty. Consequently, initial market movement will likely be dominated by the so-called "Takaichi trade": expectations that Takaichi will consolidate her support base within the party, enabling smoother implementation of her "responsible and proactive public finance" agenda. Against this backdrop, equity markets are expected to rise, the Japanese Government Bond (JGB) yield curve is likely to steepen, and the yen may face depreciation pressure. However, the bond market reaction could be more complex. A majority of market participants believe the comprehensive victory might ultimately reduce the likelihood of aggressive fiscal expansion in Japan. The Takaichi administration's fiscal stance will ultimately depend on market reactions and discussions in the upcoming national committee, including decisions on the consumption tax cut and other potential expansionary measures. This persistent uncertainty will make bond markets highly sensitive to Takaichi's future public statements, creating significant potential for substantial interest rate volatility. The yen weakened last week after Takaichi mentioned the benefits of a weaker currency in a campaign speech. The report also notes the Bank of Japan (BOJ) may be forced into a "defensive mode," accelerating the pace of monetary policy normalization through interest rate hikes. Specifically, under unchanged conditions, the BOJ had planned its next rate hike for June or July, resuming a "regular" semi-annual hiking cycle last seen before the Trump administration's reciprocal tariff announcement in April 2025. However, the report now suggests that depending on the yen's movement in the coming weeks, the timing of the next hike could be brought forward to April, or even March.

**Medium-Term Trends** After markets fully digest the election results, the focus of financial markets will shift significantly towards the feasibility of the consumption tax cut policy, including its potential scope, scale, and timing. The final outcome will largely depend on whether the Takaichi administration's fiscal policy deviates from fiscal discipline. The report points to the cabinet's approval of the FY2026 budget late last year as evidence of the government's commitment to fiscal discipline. Prime Minister Takaichi has stated the consumption tax cut will be implemented in FY2026 without relying on special deficit-covering bonds for funding. To date, no clear plan has been established to fill the resulting annual revenue shortfall, estimated at approximately 5 trillion yen. Takaichi also noted that specific details, including the distinction between a "tax exemption" and a "zero rate," require discussion and finalization by the soon-to-be-established cross-party national committee. The report expects these discussions to be lengthy due to significant controversy over funding methods, deep divisions on system design, and even opposition to the tax cut within the LDP itself. Specifically, the report believes concrete details of the tax cut are unlikely to become clear until the government drafts its first Basic Policy on Economic and Fiscal Management and Reform, collects budget requests for FY2027, and begins drafting the FY2027 tax reform plan towards the end of 2026. In other words, implementing a food consumption tax cut—whether partial or full—before the end of FY2026 is extremely difficult. Given the difficulty in reaching a quick resolution, the report expects market participants to continuously monitor the potential for a shift towards more expansionary fiscal policy. This will likely keep mild upward pressure on long-term and super-long-term JGB yields, as the market cannot fully price in or rule out any single potential scenario.

**Potential Market Reactions to Finalized Policy** The report outlines potential market reactions based on the final policy decision:

1. **If a stable funding source is secured:** The report considers the probability of finding a scheme to fill the ~5 trillion yen annual revenue gap to be relatively low. However, if achieved, it would alleviate bond and foreign exchange market concerns about Japan's fiscal discipline, even if the reduced tax rate lasted longer than two years. 2. **If no stable funding source is secured:** * **Scenario A:** The government could honor its pledge not to issue special bonds, choosing to shelve the tax cut or implement only a limited cut supported by existing funds. This would have no substantive impact on Japan's fiscal health. Eased fiscal concerns would support the yen and super-long-term JGBs, but would likely lead to a decline in public support for the Takaichi administration. * **Scenario B:** The government could proceed with a large-scale, unfunded tax cut. This would be perceived as fiscal irresponsibility, potentially triggering a "triple sell-off"—a Japanese version of the "Truss shock." Under this scenario, long-term and super-long-term JGB yields would rise significantly beyond levels seen on January 20th, accompanied by strong selling pressure on domestic equities and the yen.

The report currently assesses Scenario A as more likely than Scenario B. This is based on Prime Minister Takaichi's apparent consideration of potential market reactions, the lack of full voter endorsement for the tax cut's effectiveness as economic relief, and indirect pressure from the Trump administration.