The Japanese Yen rose at first in trading after the recent elections, even though the Liberal Democratic Party (LDP) lost its majority in the upper house for the first time since 1955. The prime minister does not plan to resign, but the government has ten days to finalize a trade deal with the US, focusing on car tariffs because of the importance of car exports.

Political Challenges and Economic Proposals

The brief relief from political uncertainty quickly faded, and the Yen lost its gains. The LDP-Komeito coalition now faces more challenges in governance, making it more dependent on opposition parties. This may lead to increased public spending due to necessary concessions. Before the elections, the government proposed a one-time payment to households to help with inflation, while the opposition wanted a permanent reduction in VAT, which would affect the national budget. The International Monetary Fund (IMF) warns that Japan’s budget deficit may rise from 2.5% of GDP to over 5% in the future. This scenario increases the risk of higher long-term bond interest rates, putting pressure on the Yen. Negotiations with the US will be the main focus in the coming days. We think the Yen’s initial rise was just a short-term reaction, and it will likely continue to weaken. The weakened ruling coalition indicates potential legislative deadlock and a greater chance of populist spending measures to gain support. This political instability suggests a less stable economy ahead. The main reason for a weaker Yen remains the gap in interest rates between Japan and other major economies. The Bank of Japan is only now starting to normalize its policy, while the U.S. Federal Reserve maintains high rates, making yen-denominated assets less appealing. Japan’s current core inflation is around 2.2%, which is not enough to prompt aggressive tightening from the traditionally cautious central bank.

Fiscal Spending Concerns

The increased possibility of higher government spending raises major concerns, especially since Japan’s government debt exceeds 260% of GDP. Any concessions made to the opposition, like the proposed VAT cut, would further worsen the budget deficit highlighted by the IMF. This situation would likely be financed through more debt, increasing the risk premium on Japanese government bonds and putting additional pressure on the Yen. In the short term, we see the US trade negotiations as a source of volatility rather than a shift in the overall trend. The current 2.5% US tariff on passenger cars is a key point that could lead to sudden, short-term currency fluctuations. We can use derivatives, such as buying USD/JPY call options, to position for Yen weakness while managing risks around this event. This environment resembles the early “Abenomics” period, where bold fiscal and monetary policies led to a rapid drop in the currency’s value. The current push for spending, combined with a hesitant central bank, creates a similar situation. Therefore, we should adjust our positions to take advantage of a weakening Yen in the coming weeks. Create your live VT Markets account and start trading now.

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