Japan is standing strong, seeking a complete exemption from US tariffs. This choice comes as Prime Minister Shigeru Ishiba, who leads a minority government in the lower house, faces the possibility of a snap election. The upcoming House of Councillors election, which must occur by July 22, complicates the current trade negotiations. These political elements make Japan’s trade discussions with the United States more challenging.

Japan’s Domestic Motivations

Japan wants full relief from tariffs, not just partial easing or specific exemptions. Their insistence on this total exemption indicates a strong internal motivation, which is causing the markets to react with caution. The Prime Minister’s hold on the lower house is shaky, making policy uncertain. In such situations, foreign partners may hesitate to respond, waiting to see the political outcome. Additionally, the upper house election by July 22 is significant for legislative changes that could affect trade strategies. This uncertainty puts Japan’s planned tariff concessions or retaliatory actions in question—likely postponed or altered without formal confirmation. Traders know that during uncertain times, market rallies may lack conviction and support zones can become unstable—easy to enter but tough to exit smoothly. Also, last week, Matsuda from the Ministry of Economy showed openness to discussing a bilateral industrial flexibility clause. However, with campaign strategies emerging within the ruling LDP, any hint of compromise might be viewed as weakness by opposition figures aiming to capitalize on voter skepticism about foreign influence. This internal posturing may not appear in headline inflation data, but it impacts trade-weighted yen forecasts, often becoming evident too late.

Market Sentiment and Positioning

Derivatives pricing is already reflecting these changes. Mid-duration options show a slight flattening, while skew is consistently leaning in one direction. When yield control policies coincide with tariff discussions, implied volatilities tend to rise quickly. We are entering a phase where positioning requires careful consideration—modest, with a clear exit strategy. It emphasizes that current sentiment is more about potential risks than economic data. Observers of cross-currency bases may have noticed a slight widening as hedgers anticipate outflows caused by trade tensions. Sato’s comments on Tuesday—mentioning that markets weren’t fully capturing the underlying uncertainty—might seem bureaucratic. However, they align with client flows showing a preference for protective strategies over bold bets. This trend indicates sentiment leaning towards caution and uncertainty. As we progress through June, monitor how forward volatility expectations compare to realized volatility. Historically, during times of political uncertainty, especially in export-driven economies, realized volatility tends to rise. Delaying action usually leads to paying more, while acting too soon can result in losses. Striking the right balance is crucial, as we’ve seen in similar situations before. It may not be dramatic, but precise timing is critical. For now, activity ratios are stable across most exchanges, but rollover demand has slightly decreased in the past two sessions, indicating a decrease in short-term confidence. Again, this isn’t an invite to take on unnecessary risk, but a signal to lower expectations for size in the coming week. While there will be some moments worth reacting to, they may not be as frequent or evenly spread as anticipated. Create your live VT Markets account and start trading now.

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