Selling Starts in Japan, Infects Other Markets as Takaichi Calls Snap Election
Here’s what’s driving this week’s weakness in Japanese markets, with record-high bond yields suggesting this trade may rapidly unwind.
You're reading 0 of 1 free page.
Register to read more or Unlock Pro — 50% Off Ends Soon
I’ve outlined recently how it’s been positive for Tokyo stocks that Japanese Prime Minister Sanae Takaichi was likely to call a snap election.
Well, now she has. And markets are suddenly scared.
What gives?
Up on Rumor, Down on News
The blue-chip Nikkei 225 index (down 1.1% on Tuesday) and the broad-market Topix (down 0.8%) both sold off Tuesday, having crested to record highs last week.
Both are still up on the year, with a greater domestic skew shoring up the 4.3% year-to-date gain in the Topix, while the Nikkei’s greater influence from exporters results in a more modest 2.2% advance so far this year.
There’s a bit of “sell on the news” after buying on the rumor last week that an early election was likely. But the selloff for Japan stocks Tuesday is the worst in Asia outside India, where the Nifty 50 dropped 1.4% amid sustained outflows from foreign institutional investors from the Mumbai market.
Takaichi said on Monday that she would dissolve the Lower House of the Diet, Japan’s parliament, as soon as it reconvenes this Friday, on January 23. The election is then set to fall on February 8, after the maximum two weeks of campaigning, as mandated by Japanese law.
Putting Her Position on the Line
The Japanese election cycle is the quickest in the world among major economies. Takaichi inherited a minority position for her Liberal Democratic Party in both the Lower and Upper House of the Diet. So she hopes a strong showing at the polls will bolster her personal mandate and make it easier for her to push through policies.
Takaichi is counting on her high personal popularity rating, cresting to 78.1% in a recent poll by the Japanese News Network, overriding the poor support for her party, sitting at just 29.7%.
“I am putting my position as prime minster on the line,” she says in calling the election, according to national broadcaster NHK. “I want the people themselves to decide whether they are willing to entrust Sanae Takaichi with the task of running our nation.”
Helped by High Tensions With China
Takaichi won an internal vote within the LDP that resulted in her becoming Japan’s first female head of state, after predecessor Shigeru Ishiba resigned as both prime minister of Japan and president of the LDP on September 7, taking responsibility for disastrous elections in July. The LDP was forced to find a new coalition partner in the form of the right-wing populist Japan Innovation Party, and even then the coalition must rely on the votes of five independent members of parliament to secure a majority in the Lower House.
Her position has been bolstered after Takaichi, a foreign-policy hawk, on November 8 said a Chinese invasion of Taiwan could present a “survival-threatening situation” for Japan. Such a phrase is a legal term under Japan’s 2015 security law, meaning Japan’s self-defense forces, its substitute for an army, could be activated in response.
China sought to hurt the Japanese economy by urging students and tourists to avoid travel to Japan. Beijing also unleashed a barrage of invective, calling such comments “egregious,” in the words of China’s foreign ministry, while China’s consul general in the Japanese city of Osaka, Xue Jian, wrote on social media that the “dirty head that sticks itself in must be cut off.” While Xue soon took down the “beheading” post, Takaichi refused to retract her remarks, and China’s hot-air bluster only appears to have strengthened her popularity back home.
Pesky Details of How to Pay
It is the number crunchers who are now causing this short spate of weakness.
Japanese Government Bonds (JGBs) have seen their yields soar to record highs Tuesday, with the 40-year JGB cresting to 4.22%, unprecedented since that bond was introduced in 2007, and the first time the yield on any JGB has topped 4.2%. The yield on the 30-year JGB is up 26.8 basis points Tuesday to 3.88%.
Why?
Takaichi is looking to continue the “Abenomics” policies of her late mentor, Shinzo Abe, letting fly the “three arrows” of high levels of government budget stimulus, low interest rates, and structural reform as ways to revitalize the Japanese economy.
If reelected, Takaichi promises to suspend an unpopular consumption tax on food products for two years, and tackle affordability in other ways. Japan’s inflation rate has remained above the central Bank of Japan’s 2.0% target since April 2022, and the supremely weak yen makes imports such as oil more expensive.
But while Takaichi has been making those crowd-pleasing promises, she has not indicated how she would pay for them. Investors figure the funding must come from increased JGB issuance. And now the weakness in JGB valuations is infecting other markets, with U.S. Treasuries, already under pressure, also selling off in sympathy.
'Canary in the Coal Mine'
The bond market is the “canary in the coal mine,” in the words of Yuuki Fukumoto, senior financial researcher at NLI Research Institute, as quoted by Bloomberg. “From an investor’s perspective, it’s hard to see a scenario where buying bonds makes sense.”
However, there’s also a risk that Japanese bond yields become attractive enough that Japanese institutional investors decide to repatriate money invested overseas, to buy low-value, high-yield JGBs. That would prompt a rapid unwinding of the yen carry trade, where investors borrow in low-interest-rate Japan to buy overseas assets.
Such a scenario would create sustained strengthening pressure for the Japanese yen, not far off the levels of last July, when it climbed close to ¥162 to the U.S. dollar. It now stands at ¥157.89. It has lost 7.1% of its value since Takaichi won the internal LDP leadership, when the yen traded at ¥147.44 to the greenback, despite recent weakness in the U.S. dollar.
