Prime Minister Sanae Takaichi’s election victory raises concerns in the market about possible changes to fiscal and monetary policies, which might weaken the Japanese Yen. However, there are scenarios where the Yen could actually strengthen. This may happen if the market reacts negatively to increasing debt or if the Bank of Japan tightens its policies more quickly than expected due to inflation.
With Takaichi in a strong position, the government can pass laws without needing approval from the upper house, raising fears of aggressive fiscal policies. The markets worry that the Bank of Japan may shift away from its cautious approach to policy normalization. If Japanese government bonds become less attractive because of debt worries, the government might need to change its policies to prevent financial instability.
Potential Fiscal and Monetary Changes
In response, the Bank of Japan could keep interest rates high to manage inflation. Keeping interest rates elevated for too long might make it tough to service national debt, but it could be necessary to keep inflation in check.
With Takaichi’s supermajority, we anticipate continued downward pressure on the Japanese Yen in the short term. The market is anticipating a very expansionary fiscal policy and fears she could stop the Bank of Japan’s slow normalization process. As a result, the USD/JPY has moved toward the 168 level, reflecting these concerns.
Given the risk of a sudden policy change, taking a simple short yen position is risky. Instead, a better strategy could be to prepare for a spike in currency volatility, which is already approaching its highest levels since the upheaval of 2024. Buying three-to-six month USD/JPY straddles or strangles could help a trader profit from a significant move, whether that’s a yen drop or a quick recovery.
We are keeping an eye out for a potential backlash against Japanese government bonds, which could lead to a fast rise in the yen’s value. The yield on the 10-year JGB recently spiked to 1.5%, signaling that investors are starting to worry about the country’s rising debt. We saw a similar situation during the UK’s fiscal crisis in 2022, where a market revolt forced a complete policy change and strengthened the pound.
Possible Triggers for Yen Reversal
Another key factor for a yen reversal would be if the Bank of Japan acts more decisively than the government anticipates. In January, core inflation was a stubborn 3.5%, putting pressure on the central bank to stick to its goals. If there are signs that the BoJ will speed up its tightening cycle to tackle inflation, this could lead to a rapid reversal of short yen positions.
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