Japan's Liberal Democratic Party (LDP) is expected to achieve an overwhelming victory in the February 8th Lower House election, prompting a resurgence of so-called "Takaichi trades."
According to analysis, a recent Barclays report notes that while the LDP is poised for a decisive win in the February 8th Lower House election, the potential upside for the anticipated "Takaichi trade" – a scenario involving equity gains, yen depreciation, and a steeper yield curve driven by fiscal expansion – is now quite constrained. It was reported that Japanese Prime Minister Sanae Takaichi announced at a press conference on January 19th that the Lower House election would be held on February 8th, as the term for the current Lower House members was originally set to expire in October 2028.
The report argues that an electoral landslide could paradoxically limit the scope for fiscal easing, as persistent yen weakness and political pressure from the United States will likely compel the Takaichi administration to pivot towards fiscal discipline. Regarding monetary policy, despite the government's preference for maintaining an accommodative stance, pressure from exchange rates and inflation will force it to accept a shift towards interest rate hikes by the Bank of Japan. From a medium-to-long-term perspective, the Japanese Government Bond (JGB) yield curve may exhibit a "twist-flattening" pattern, while the USD/JPY pair will face a clear ceiling for policy intervention above the 150 level.
Contrasting with this view, as the election nears, actual trading activity still shows short-term enthusiasm for the "Takaichi trade," with markets already positioning for a weaker yen. On Wednesday, the USD/JPY rate climbed to the mid-156-157 range, reaching its highest point in nearly two weeks. Recent public comments from Prime Minister Takaichi suggesting that yen weakness is beneficial for the economy, combined with polls indicating her party is likely to secure an absolute majority, have further solidified market expectations for enhanced fiscal stimulus following the election.
The options market has already begun pricing in this anticipated shift. Data shows that on Tuesday, trading volume for USD/JPY call options significantly surpassed that of put options, with single-day turnover exceeding $1 billion, a trend that continued into the Asian trading session on Wednesday. As demand for calls increased, the one-month USD/JPY risk reversal indicator fell to its lowest level in nearly two weeks, indicating a relative decrease in market demand for hedging against downside currency risk.
Antony Foster, head of G-10 spot trading at Nomura International, noted that as speculative sentiment in precious metals markets gradually subsides, hedge funds are refocusing on carry trades and the logic of the "Takaichi trade." He stated:
"If Sanae Takaichi secures a major victory in the election, market expectations for further gains in USD/JPY will be reinforced."
Election Outlook: LDP Heading for "Absolute Stable Majority" The Barclays report indicates that the election landscape for Japan's Lower House is currently highly predictable and one-sided. Aggregating recent surveys from several major news organizations suggests the ruling LDP is expected to single-handedly win more than half of the seats.
A key target is for the ruling coalition to potentially reach the "absolute stable majority" threshold of 261 seats in the Lower House. Achieving this would grant the coalition the right to chair all standing committees in the Lower House and hold a majority on each committee, thereby gaining comprehensive control over the pace of the legislative agenda.
The latest polling data further strengthens this expectation. Although public support for the Takaichi cabinet dipped slightly in January to 67% from 75% in December, it remains at a high level; concurrently, the LDP's party support rate has climbed to 42%, indicating a relatively solid voter base.
While some voters remain undecided, market expectations are increasingly converging on the view that an "LDP landslide victory" will be the final outcome of this election, with related political pricing gradually being reflected in asset values.
Core Scenario: Reshaping Policy Logic After a Major Victory Fiscal Constraints: External Pressure and Market Reaction Will Curb Expansionary Ambitions Barclays analysis suggests that if the LDP wins a decisive victory, the Takaichi government is expected to initially push for more proactive fiscal policies, including discussions on establishing a "National Council" to study temporary exemptions for food from the consumption tax. However, the actual scope for fiscal expansion will be significantly constrained, with further tax cuts likely proving difficult to implement.
A key constraint comes from external forces. In a foreign exchange report released on January 29th, the US Treasury Department explicitly identified the "potential for more expansionary fiscal policy from the new Japanese government" as a core driver of yen weakness. This signals a shift in US focus from Japanese monetary policy to its fiscal path, suggesting that expansionary policies disregarding fiscal discipline could provoke explicit countermeasures from Washington.
Significant implementation challenges also exist internally. Taking consumption tax cuts as an example, estimated to cost around ¥5 trillion, they face substantial practical hurdles and funding difficulties. Barclays judges that such measures are likely to be postponed until fiscal year 2027 or later, and even if implemented, their scale could be reduced.
Notably, a change in the political landscape could paradoxically strengthen fiscal discipline. If an overwhelming victory reduces the LDP's reliance on opposition parties, it would grant the government greater political latitude to pivot towards a more sustainable fiscal path when faced with market pressures.
Monetary Policy: From Political Pressure to Pragmatic Compromise On monetary policy, although the new government may initially pressure the Bank of Japan to maintain stable interest rates, market reactions will quickly become the decisive factor. If the yen weakens further due to policy divergence and yields climb, it will force a governmental adjustment in stance.
The report concludes that the government will ultimately have to revert to a stance of "passively accepting rate hikes" to counter excessive yen depreciation pressures and maintain macroeconomic and financial market stability.
Market Outlook: Trading Dynamics and Key Levels In the rates market, a shift from short-term steepening to medium-term flattening is anticipated. Following the election results, the rates market is expected to initially follow the "Takaichi trade" logic, exhibiting a short-term steepening trend, particularly evident in rising ultra-long-term bond yields. However, as the fiscal policy path becomes clearer, market attention will gradually shift towards the prospect of sustained monetary tightening.
Barclays points out that as fiscal risk premiums diminish due to increased political constraints and the Bank of Japan continues its rate-hike cycle, the yield curve will enter a "twist-flattening" phase, where upward pressure on short-end rates exceeds that on the long-end. Some major domestic Japanese life insurers have already indicated that current yield levels offer attractive allocation value, suggesting that institutional buying of ultra-long-term bonds is expected to gradually return once fiscal uncertainty subsides.
In the foreign exchange market, the yen's downside faces multiple constraints. Although the election outcome might trigger short-term yen weakness, the potential for further depreciation is limited. Barclays believes the USD/JPY pair will encounter significant resistance in the high 150s. Key intervention watch levels include 159 (where authorities previously conducted rate checks), the significant psychological barrier of 160, and the 2024 high of 162. Fundamentally, Barclays models estimate the fair value for USD/JPY is in the high 140s, but accounting for the short-term impact of a "Takaichi premium," the exchange rate is expected to find support near 150, forming the lower bound of the recent fluctuation range.
Tail Risk Scenarios Scenario Two: LDP Wins by a Slim Majority If the LDP secures only a narrow majority, the Takaichi government's ability to implement policies would be significantly hampered. To maintain ruling stability, the government might be forced to compromise with opposition parties on fiscal policy, potentially adopting proposals such as raising income guarantee thresholds and stabilizing energy prices, thereby prolonging fiscal expansion pressures.
In market terms, an initial mild unwinding of the "Takaichi trade" could occur, manifesting as a slight pullback in yields and gradual yen appreciation. Over the medium to long term, persistent fiscal uncertainty would likely keep markets in a wide, range-bound pattern, making it difficult to establish a clear directional trend.
Scenario Three: LDP Defeat and Reform Coalition Government Should a centrist reform coalition led by the Constitutional Democratic Party come to power, the political landscape would face high instability. This coalition tends to favor fiscal expansion policies centered on redistribution but lacks stable and reliable funding sources. Regarding monetary policy, it would be more respectful of the Bank of Japan's independence and might more readily accept interest rate hikes to address inflation pressures.
This would lead to significant structural market changes: the "Takaichi trade" would be rapidly and substantially unwound, putting pressure on equities and causing the yen to strengthen quickly. However, due to severe market concerns about fiscal sustainability, the term premium on long-term bonds could face an upside risk of approximately 30 basis points, driving ultra-long-term yields significantly higher. On the exchange rate front, after a short-term appreciation phase, the yen could re-enter a depreciation trajectory due to deteriorating fiscal prospects.