The Japanese yen started the week strong, with USD/JPY around 147.85 and EUR/JPY at 172.10. This strength follows Japan’s weekend election, where Prime Minister Shigeru Ishiba’s ruling coalition lost its majority in the upper house. The Liberal Democratic Party and its partner Komeito did not reach the 50-seat threshold needed for a majority in the 248-seat chamber. Opposition parties, which promised tax cuts, gained more seats, along with an anti-immigration party.

Government Challenges and Yen Volatility

While the election outcome does not immediately threaten the government, it puts pressure on Ishiba ahead of an August 1 deadline for U.S.-imposed tariffs. Calls for leadership change within the LDP are expected to grow. Even though the yen is strengthening, we anticipate volatility. The loss of control may lead to uncertainty in policy. Typically, this uncertainty supports the yen as a safe haven, but possible pressure for tax cuts and increased spending may weaken the yen in the medium term. We think the initial strength of the yen is a short-term reaction to political uncertainty. The loss of majority in the upper house creates gridlock, which traders see as a safe-haven signal. However, we expect volatility to create opportunities as the underlying conditions become clear again. The main issue is the large interest rate gap between Japan and other major economies. The Bank of Japan’s policy rate is close to 0.1%, while the U.S. Federal Reserve’s rate is between 5.25% and 5.50%. This gap has been the main cause of yen weakness for over two years and is unlikely to change because of this election outcome.

Implications for Fiscal Policy and the Yen

The setback for Ishiba’s coalition makes it harder for the central bank to adjust its policy. Political pressure will increase for populist measures like tax cuts or more spending, which need low borrowing costs to work. This reinforces the idea that the currency will weaken in the medium term. In the past, times of political weakness in Japan often led to more fiscal stimulus instead of austerity. We saw this during Japan’s ‘Lost Decades,’ where extra budgets were used to support a struggling economy. This suggests that the government’s response to its weakened position will likely hurt the yen. Given this outlook, we see opportunities in derivative contracts that position for a reversal in the yen’s recent strength. For example, buying call options on USD/JPY allows traders to profit if the currency moves back toward 150 or higher, while limiting downside risk. This strategy benefits from both expected yen weakness and high volatility. The upcoming August 1st deadline for potential U.S. tariffs introduces more event risk. A weakened government may find it difficult in trade negotiations, adding uncertainty that could impact the currency. Therefore, we should consider options strategies that can handle sharp price fluctuations around that date. Create your live VT Markets account and start trading now.

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