Japanese media report that Prime Minister Shigeru Ishiba’s government may lose its majority. The upcoming upper house by-elections this weekend are crucial for testing Ishiba’s leadership and the viability of his minority government, which collaborates with Komeito. The government faces declining approval ratings and growing public worries about living costs and the economy. While it’s unlikely the ruling coalition will lose power altogether, unfavorable election results could threaten Ishiba’s role.

Opposition and Economic Policies

The opposition is advocating for tax cuts and increased fiscal stimulus, which could gain momentum if the election results favor them. These results will affect economic policies, budget discussions, and the balance of power in the Diet. If spending-focused or populist policies gain support, this could impact the markets. Nikkei has pointed out these concerns, highlighting the vulnerability of Ishiba’s coalition in the current political climate. We view the political shifts in Tokyo not as a danger but as a unique opportunity. The market seems to be overlooking this weekend’s by-elections, and now is the time to prepare for increased volatility. Ishiba’s cabinet approval rating recently dropped to just 25.7%, the lowest in his term, making the chance of a political upset more likely than current market prices indicate. This situation isn’t just show; it could directly influence monetary and fiscal policy changes.

Market Strategy and Implications

The Nikkei Volatility Index, the VXJ, has been steady at a low 17. This is an inexpensive form of protection, making it an ideal time to buy volatility before the results. Any indication that Ishiba’s coalition is weakening will encourage the opposition and their calls for more spending. Historically, similar policy directions have negatively impacted the yen while benefiting equities. A poor performance by the ruling coalition could push the USD/JPY pair past the critical 160 level, a psychological threshold that the Ministry of Finance is striving to maintain. Our strategy centers on options, not predicting a specific outcome but recognizing that the result will likely lead to significant market movement. A weaker government would mean increased spending, delaying any strong measures from the Bank of Japan as it grapples with persistent inflation above its 2% target, with core CPI reaching 2.5% in May. This scenario favors long Nikkei 225 calls and long USD/JPY calls. Conversely, if the ruling coalition surprises with a strong showing, it may suggest a mandate for fiscal responsibility, allowing the Bank of Japan to move towards normalization, which would likely lead to a stronger yen and lower Nikkei. Given these two possible outcomes, executing a long straddle on Nikkei futures or a strangle on the USD/JPY is a smart move. This strategy allows us to benefit from significant price swings in either direction. The market has presented a low implied volatility gift just before an event that could drastically change Japan’s economic landscape. Create your live VT Markets account and start trading now.

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