The Japanese Yen has weakened due to a drop in government bonds after Prime Minister Takaichi announced a snap election. The key agenda includes a two-year food tax reduction, which raises concerns about Japan’s financial discipline. The election process begins with the lower house dissolving on January 23, campaigning starting on January 27, and voting on February 8. Takaichi plans to lower the sales tax on food from 8% to 0% if he wins. Despite worries in the market, current signs indicate that Japan has a stable economic outlook. Nominal GDP growth is around 4%, and 10-year government bond yields are about 2.3%. This suggests Japan can handle primary budget deficits. These indicators point to a healthy fiscal environment, where growth is faster than borrowing costs. Therefore, the risks to Japan’s finances might not be as serious as the market believes. This means Japan’s financial stability looks stronger than expected.

Market Reactions To Fiscal Policy

Last year at this time, markets were anxious about Prime Minister Takaichi’s stimulus plans and the snap election. The yen fell, and government bonds were sold off due to fears of fiscal recklessness. However, those concerns now seem exaggerated as the economy adapted to the changes. The belief that Japan could manage its spending has proven accurate. In the fourth quarter of 2025, Japan’s nominal GDP growth was a solid 3.5%, indicating ongoing economic expansion that outstrips borrowing costs. As a result, the 10-year Japanese Government Bond yields have stabilized, currently trading around 2.5% after an initial spike in early 2025. This bond market stability contrasts with the yen’s ongoing decline, driven by interest rate differences. The USD/JPY exchange rate recently hit a multi-decade high of 161.50 in late December 2025, influenced more by US Federal Reserve policy than by fiscal issues in Tokyo. This situation offers clear opportunities for derivative traders.

Potential Policy Shifts And Trading Strategies

Japan’s core inflation for December 2025 was 2.8%, indicating a growing likelihood of a Bank of Japan policy change later this year. Traders might consider buying JPY call options or selling USD/JPY call spreads to prepare for a potential price correction. With high implied volatility, options strategies that take advantage of price movement, like long straddles, could be beneficial. In the rates market, options on JGB futures can help trade expectations of a gradual and well-communicated policy change. We expect the Bank of Japan to proceed cautiously, making a sharp increase in yields unlikely in the next few weeks. Thus, selling out-of-the-money calls on JGB futures could be a good strategy to earn premiums from decreasing volatility. Create your live VT Markets account and start trading now.

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