What Japanese Snap Elections Mean for The Yen

Japan is headed to the polls on Sunday to ratify the premiership of Sanae Takaichi, who has an ambitious spending and tax-cut programme that has markets a little nervous.

The Key Developments

• The yen weakens as Takaichi is expected to win a resounding victory in Sunday's snap election.
• Her proposals to increase spending while cutting taxes have left traders nervous about the country's ability to meet its debt obligations, which has raised long-term yields.
• The Japanese bond selloff could intensify if the BOJ remains reluctant to intervene, potentially further weakening the yen.

Japanese Elections and Weaker Yen

The yen has generally weakened this week, though it has stayed short of levels earlier in the month that prompted the New York Fed to initiate a rate check to stabilise the currency. Traders believe that the snap election called for this Sunday will strengthen Prime Minister Sanae Takaishi's mandate, allowing for increased government spending and lower taxes. Given Japan's already high level of debt, the proposals are expected to weaken investor confidence in the country's financial situation as the BOJ is on a tightening track. The concern is similar to the "mini budget" crisis in the UK in 2022, when investors sold off long-term debt amid fears that the government would struggle to service its debt. The BOE was forced to intervene in order to stabilise markets.

What caused additional consternation among markets this week were reports that the BOJ would not intervene to "rescue" the government if bond yields spike in the wake of the election. The volatility in Japanese yields has spilt into the debt market, affecting other assets in the process. As the major nation with the lowest yields, JGBs set an interest rate "floor". If Takaichi were to win substantially in the election and use the mandate to support aggressive spending and tax-cut measures to boost the economy, JGB yields could rise and push global yields higher in the process. Such an outcome would also continue to weaken the yen, as the closing of the interest rate gap would drive out carry traders, potentially pushing the USDJPY back to the 160.00 handle that previously prompted intervention. However, after US Treasury Secretary Scott Bessent dismissed intervention to support the yen amid a push to shore up the dollar, markets could be more willing to push the currency pair higher.

Expectations for Japanese Snap Election

Sanae Takaichi became Prime Minister last October after winning an internal election for her LDP party, and she was widely expected to call elections to ratify her mandate. She's characterised as a hard conservative and admirer of Margaret Thatcher, and during her campaign has touted fiscal liberalism to boost Japan's sluggish economy. This election poses a particular headache for the BOJ, which is dealing with high inflation as the weaker yen pushes up the cost of imported goods. The central bank has been cautiously raising rates to combat high inflation and strengthen the currency without causing the bond yields to spike.

Many observers believe the BOJ will be forced to raise rates more quickly if Takaichi has a strong showing, as her policies are considered inflationary. Polls suggest her LDP party and coalition partner could win as many as 300 seats, well above the 233 needed to govern, and indicate a strong mandate. If her support isn't as much as expected, traders might price in a less aggressive spending programme, which could return some strength to the yen. On the other hand, if her party fails to secure the 233 seats, the resulting political uncertainty might also weaken the yen.

USDJPY Weekly Pin Bar Suggests Takaichi Win

The long-term chart of USDJPY shows a clear double-top formation that formed shy of the 160.00 handle. However, it also reveals a weekly pin bar at the low of 152.00 after prices tested the VWAP median line, suggesting markets are pricing in a win for Takaichi. This brings into focus the pre-intervention high of 162.00 in 2024, which would be followed by 165.00 if the Japanese PM secures a landslide victory. However, the round resistance may still offer short-term resistance, with the VWAP high sitting at just 160.24. On the flip side, disappointing results for Takaichi would weigh on USDJPY, exposing the 150.00 psychological support, with an interim level sitting at the weekly open of 155.00. The long-term structure has a sideways look. However, without losing the VWAP floor at 148.47, the odds of sliding all the way down to 140.00 remain slim.