With Japan's snap election commencing on Tuesday, investors are bracing for heightened volatility in the bond market, potential government intervention in the foreign exchange market, and frequent fluctuations in the stock market. Previously, concerns over expanded government fiscal spending triggered a bond market crash, resulting in substantial investor losses and increasing the government's debt servicing pressure. The market is now scrutinizing every shift in stance by various political parties on policy issues such as government expenditure and tax cuts. Prime Minister Sanae Takaichi's proposed two-year food consumption tax reduction plan, coupled with her policy inclination towards military expansion, has already caused significant divergence in stock market sector performance. As the February 8th voting day approaches, the yen's substantial volatility continues to transmit to various asset prices both domestically and internationally. Although her approval ratings have recently dipped, most polls indicate that Sanae Takaichi's support remains stable above 65%; with just two weeks until the election, this data confirms her solid public support base.

Traders are broadly betting that this election will further solidify Prime Minister Takaichi's governing mandate, giving her greater confidence to advance subsequent economic stimulus measures. From an overall market logic perspective, the trading strategy named after her essentially involves going long on stocks, shorting the yen, and simultaneously betting on falling bond prices and rising yields. Rinto Maruyama, a foreign exchange and rates strategist at SMBC Nikko Securities, stated, "There is a high probability of the market returning to the traditional 'Takachi trade' strategy." However, he cautioned that the yen's trajectory remains highly uncertain. Maruyama pointed out that the USD/JPY exchange rate still has room to rise post-election, with signs suggesting Japan and the US might cooperate to stabilize the forex market, which would make it difficult for the exchange rate to break above the 156-157 range. "But if no intervention occurs from both countries, a break above this level could potentially drive the rate above 160." As of this report, the USD/JPY rate hovers around 154.21. Currently, Prime Minister Takaichi has not specified the funding source for her tax cut policy; Japan's Ministry of Finance estimates the annual fiscal cost of this policy to be approximately 5 trillion yen (about $32 billion). The largest opposition party, the centrist Reform Coalition, has promised permanent tax cuts on food, raising market concerns that Japan's fiscal discipline will further loosen regardless of the election outcome.

Fabien Yip, a market analyst at IG, stated, "If the main opposition coalition performs better than expected and the ruling coalition loses its parliamentary majority, political instability could further exert dual pressure on both the stock and bond markets."

Even if opposition parties win the election, food-related sectors such as supermarket operators could still benefit if the government ultimately implements the food consumption tax reduction policy. Boosted by tax cut expectations, supermarket chain Life Corp. recorded its largest weekly gain since April 2024 last week. Hiroyuki Ueno, chief strategist at Sumitomo Mitsui Trust Asset Management, stated that if Sanae Takaichi leads the ruling coalition to secure a parliamentary majority, her commitment to expanding defense budgets would make defense and military technology stocks among the biggest winners. He added that construction, semiconductor, and artificial intelligence sectors would also benefit from her fiscal spending plans. It is important to note that the recent rebound of the yen from its cyclical lows has pressured export-oriented companies, while bond market volatility has dampened overall risk appetite, causing the Japanese stock market to retreat from its historical highs. Since the Bank of Japan initiated monetary policy normalization in 2024, rising interest rates had pushed financial stocks higher; however, concerns that falling bond prices might lead to unrealized losses on banks' asset holdings are now weighing on bank shares.

Yujiro Goto, chief foreign exchange strategist at Nomura Securities, stated, "Following the significant rise in Japanese Government Bond yields, negative feedback has emerged in the stock market; we need to be vigilant about recent abnormal price movements." He noted that stock market weakness might prompt the Takaichi cabinet to adjust its policy direction post-election, potentially tightening its expansionary fiscal and monetary policies. Following the Bank of Japan's decision to keep interest rates unchanged last Friday, investors are also closely watching the election's impact on the central bank's policy path. As a known monetary policy dove, if Sanae Takaichi's influence increases further, the Bank of Japan could face pressure to delay interest rate hikes, which might also exacerbate the yen's depreciation trend. IG's Yip emphasized, "The key point is that the Bank of Japan's policy normalization process and yen stability must be prioritized. Even if the food tax is suspended, yen depreciation would still push up import prices, ultimately failing to address the cost-of-living issues the tax cut policy aims to solve."

Earlier this year, the yen fell to its lowest level against the US dollar since July 2024, but it currently hovers near its highest levels since last November. Faced with a weak yen and high government bond yields, Sanae Takaichi issued a fresh warning to financial markets last Sunday, stating the government is prepared to take action. The Japanese government intervened last year when the yen fell to 160.17, subsequently operating in the market at key levels such as 157.99, 161.76, and 159.45. Nomura's Goto said, "Current market expectations for the risk of government FX intervention have risen significantly. If the yen continues to weaken, the Bank of Japan might consider an earlier rate hike around April; therefore, we judge that the upside for USD/JPY above 160 is limited."

Another core concern for investors is how Japan's relationship with China will evolve after the election, following the diplomatic dispute that began last year after Sanae Takaichi made erroneous remarks regarding China's Taiwan region. In January this year, China announced new export controls on dual-use items and initiated an anti-dumping investigation on a key semiconductor manufacturing material. "For Japan, the current friction with China is the biggest issue, while the impact of the Russia-Ukraine conflict is also immediate," said Sumitomo Mitsui Trust's Ueno. "Therefore, if Sanae Takaichi consolidates her position through the election, it would inject multiple dynamics into the market and the domestic Japanese economy." Shigeto Nagai, Head of Japan at Oxford Economics, pointed out that even if opposition parties achieve a decisive victory, Japanese assets could still rally if it brings clearer political stability. Nagai stated, "What global investors truly crave is certainty. For decades, political stability has been a core attraction of the Japanese market, but that advantage has now diminished."