Japan, Politics and the Yen - Is It All Priced?

Welcome to the MUFG Global Markets FX Week Ahead podcast with Derek Halperny, Head of Research Global Markets, EMEA and International Securities. It's Friday the 18th of July 2025 and joining Derek to pose some questions on the financial market themes for the week ahead is Chris Jakabowski, Head of Hedge Fund, FX Sales. The following podcast is intended for professional investors and eligible counterparties only and not for retail clients.

Any content should not be regarded as an offer to conduct investment business or an investment recommendation, but for information purposes only. Hi Derek. Hi Chris.

How are you? Yeah, I'm very well, thanks. And yourself?

Good. Yeah, not too bad. Not too bad.

Thank you. Good, good. So this week, I think it goes without saying, we will probably focus on the upcoming elections because it's all the questions I'm getting currently, so I'm pretty sure it's similar for you.

Yeah. Let's just kick things off with sort of laying down the context. Where we are now and what's happened changed this week, you know, local media reports and, you know, our local staff as well, everyone's predicting that it could now be sub 40 seats.

How have expectations changed this week and how have you positioned yourself for that? Yeah, like the polls have been becoming, certainly it looks more consistent in terms of indicating a potential loss of majority. So, you know, there's 125 seats being contested, 66 are held by the coalition, they already hold 75 that won't be contested, therefore the need to win 50 to maintain its overall majority.

And yeah, as you said, they've honed in, some of the polling has honed in on the single seat constituencies, because that's, I guess, easier to kind of indicate the potential for loss. And certainly in terms of one of the polls this week was suggesting in the 32 single seats that the LDP holds, they're only ahead in 12. The opposition is ahead in nine, and it's a 50-50 call in the other 11.

So, you know, you break that down in terms of, you know, half the 50-50s and the opposition's holding those, you get to a figure plus New Cameto holding on to 10 of their 14, and that gets you to a figure that is below that 50 threshold that's needed for the combined LDP-New Cameto. So yeah, like I would say, dollar yen at these levels is certainly incorporating a good degree of prospects of that happening. I think it's certainly more price than loss.

So in other words, if they did manage to hold on to the majority, I think you'd get a bigger correction lower than you will a correction higher on losing that majority. But, you know, it's a bit less clear in terms of, obviously, maintaining the majority, it's pretty clean. There's no scenarios.

That's it. Whereas if they lose the majority, there's a few different scenarios. I think as those play out in the first couple of days, it could get worse.

Fears of not just a new leadership election, but potentially a new general election after that, and suddenly you're into a vacuum of a prolonged period of time. And then, of course, with the 1st of August being the date for the trade tariffs to get alive, in that scenario, it becomes less likely you get a trade deal. Then there's, you know, Sine Takeuchi, who lost the runoff against Toshiba last year.

She is one of the candidates, and she's pro-economics, fiscal spending, blah, blah, blah. And then, boom, you're through 150 and trading 151, you know, in a short number of days post that election. So you don't think there's too much, because I'm hearing, like when I was speaking to some of the guys over in Tokyo or some clients and stuff like that, there's, you know, they like to just get it as a sort of exact levels.

And they're like saying if it's sub-40, they think it goes through to 151 on the open. Less than 30, I've heard 152. Do you think that there won't be such spikes in volatility and, you know, moves in dollar yen, and it would be sort of more a wait and see what happens when that unfolds, like you mentioned, who will come in and what will happen with the leadership, et cetera, et cetera?

I don't know. Or what, 148, 40, 30, 40, I don't know, spiking, opening at 151, I'd be surprised, because I think it's more priced than that. Also to throw into the mix, of course, it's a Japan holiday on Monday.

So that obviously creates the potential for that move. Yeah, exactly. So a bang on the open, of course, you know, it's difficult to predict, but I think there's scope to get to those kind of levels, certainly.

So let's not quibble in terms of whether it's day one or day three, but I think definitely we can get there based on, you know, this potentially getting a bit messy. And, you know, one of the interesting elements of this is this new, well, it's a growing popularity, the populist right-wing Sensaito party, and, you know, the polls in the last couple of weeks have shown them with some big increases. So you throw that into the mix as well, and you certainly, I think, have the prospects for losing the majority, but also the voter results showing the increased anger in terms of the cost of living crisis and the lack of leadership and the weak political backdrop that we've had.

And I think the disgrace with the LDP, not just now, but in recent years, has been the degree of division in the opposition parties. And if anything, maybe that will still be the case after this election. But, you know, it is an upper house election, and generally these elections wouldn't be, of course, as important as the lower house elections, and to some degree that's true, but there's never been a, well, it's been some time since there's been such a prospect of leadership change on the back of an upper house election.

The fact that he lost the lower house majority last year, he loses this, like, really? Can he survive? Because it seems like it's more than just an upper house election, it's a popularity vote, right?

It's kind of endorsing whether they are going to be able to keep hold of their position and whether the people want change, and they want, you know, because of this sort of being completely disenfranchised with politics in the sense that they can't afford, you know, you know, cost of living is going up and wages aren't matching it, and they're being completely disenfranchised, especially from what I was hearing from sort of youth parts within, you know, youth voting is going up because they're the hardest hit by these, basically the cost of living crisis. And it whether, you know, and my point being is it's not going to just simply be an upper house election. It's a rejection of the current political, you know, system, in a sense.

Yeah. No, absolutely. You know, depending on the momentum of what we see in this voter shift, obviously the bigger the momentum in that kind of direction, the greater the prospects of, you know, something more meaningful in the next lower house election and what the kind of landscape looks like over the next five, 10 years and beyond.

So it is, it is pretty crucial. And of course, you know, we're talking in kind of big things in the way we're talking about this, but, you know, the macro backdrop explains all this. And for 30 years, you know, you had no inflation and mild deflation and they needed to shift back into positive inflation.

They have that now, but it's quite disruptive politically. Yeah. And the fallout from that, I think, is still ahead of us.

Yeah. And that's it. I mean, it seems more systemic than just political, but I mean, I guess that brings us on to another point in the sense that, you know, if the government changes tact or if there is a new government in place, which do these populist policies, which will be to cut taxation and, you know, fiscally change the situation in Japan, that then begs the question whether then, you know, people will see this as, you know, a issue for stability within the country and, you know, what would then happen with rates and this credit outlook and the rest of it?

I mean, that all comes into question then, doesn't it? Yeah, no, absolutely. I think the real question is, OK, let's say, for example, that the coalition government's policies at the moment are that they're going to give further handouts to support households with the cost of living prices.

Now, we're talking about about three and a half trillion yen. So that, according to Ueshiba, will be financed by rollover surpluses from previous years. Revenues.

The good story here is that inflation is creating revenues that are more than what were projected in fiscal planning. So there's, according to the government, there will be that surplus. So there will not be JGB issues.

With the opposition party, though, you've got calls for the consumption tax rate to be cut. That's expensive and that can't be done without JGB issues. So there's where you have the division and the political risk premium being priced into the JGB market.

Now, the question, I think the real question here is, will the JGB market allow for the opposition parties if they get the chance to implement their tax policies? And I think the answer is no. We've already had, you know, since the 3rd of July, I'm marking the 3rd of July, that was when payrolls came out and there was a bit of a pickup globally in yields, of course.

But in Japan, we've had to the high this week, the 30 years of 37 basis points. So this is basically looking at a chart. This is the, what is it, the 3rd, 1, 2, 3, it's the 4th abrupt sell-off in the last five months.

March, April, May, and July. June, we had a period of relative stability. So clearly, super long JGBs are vulnerable, and we're seeing a lot of market dislocation and disruption.

So, you know, clearly, bond investors are a lot more nervous, and what's happening is essentially domestic investors are staying away at the moment. Foreign investors have been coming in, but whenever they pause or pull out or correct, then you potentially get a blow-up, and that's happened, and foreigners are the ones that are getting hit in terms of losses, in terms of trying to buy the top in yields. But ultimately, to your question in relation to sovereign ratings, it's interesting, because this month we had an S&P update, and in fact, you know, they were, given what's going on, they were reasonably, I wouldn't say optimistic, but they were quite balanced, because they were pointing out things like what's called the reflationary dynamics.

So of course, let's not forget inflation is a good thing in terms of lifting nominal GDP, which is the denominator when we're measuring net GDP, and therefore, high inflation, stronger nominal GDP, is actually bringing down debt to GDP, still extraordinarily high, of course. So I think that's a positive that maybe it's a little bit overlooked. Also, of course, the actual running fiscal deficit, the budget deficit, has dropped, the deficit has dropped, yes, to the latest reading is 2.2% of GDP, and if you look at the chart of that, that's actually the smallest deficit since the 1990s.

So they are bringing that back in under control, but, you know, obviously, the overall position is still problematic, especially if the opposition get their way. Given what's happened in the GDP markets in recent months, you know, if they suggest they're going to do that, the GDP markets blow out, we get a surge in yields, they won't be able to do it, basically. I think the markets will force them to renege on that promise, but that, you know, we do get the market disruption, of course, before the 40s, and of course, from a yen perspective, there's a negative link with correlation in terms of higher yields, weaker currency.

So you can certainly see the yen weakened further on the back of that as well. And then potentially moving on to the saviour, and that being a US trade deal announcement, the possibility of that coming sooner rather than later and maybe save some political positioning for the LDP, what are your thoughts on that, and how are we positioned? Yeah, well, again, it's quite tied to the election in terms of what the political backdrop is on Monday morning.

Obviously, you know, Scott Besant is in Japan today, he's at the Expo 2025 in Osaka, and he's gone to Tokyo as well, and they've had a meeting, and there's been nice, kind words said, and Scott Besant has said there's, you know, a chance for a good deal to be done. I think that the strategy from Japan has clearly not worked, which, you know, I think giving ultimatums to President Trump is never a good strategy, is it? And I think Japan wanted what the UK got, which is this quota-related lower auto tariff.

But the US isn't going to budge on that kind of ultimatum of lower the auto tariff, and then we'll talk about everything else. So, they're in a difficult position. Obviously, politically, come Monday morning, if they've maintained the majority, it doesn't matter then.

The political cost is not irrelevant, but it's easier to give away that political capital on Monday morning. If they've lost their majority, then it's, yeah, it's quite messy, and the potential for him to do a quick deal is a lot less. My guess is he's going to try and hold on, unless it's a really bad result.

So, he might try and hold on, but, you know, then compromises fiscally will need to be done, and then that threatens the JPP market, and then all in this trying to focus on getting a trade deal done, it becomes quite difficult. I think a deal will be done. I'm not saying necessarily it'll be before the 1st of August.

I'm not saying necessarily it'll be before the 1st of August. You may need to fall into the scenario to kind of focus the minds and for Japan to maybe backtrack or nudge their position a little bit, and then we get something done. But, you know, I think the markets are expecting that as well.

The long list of letters that were sent out, really, from a global macro perspective, it's the Japan tariff, it's the South Korean tariff, and it's the EU tariff. Those are the three biggest economies in the long list that's been – well, Canada and Mexico, but Canada and Mexico are a lot more protected by the USMCA deal in terms of those goods that are compliant under that agreement. So, yeah, if we get deals on those three, it kind of dilutes from a macro perspective a lot of the other tariffs, which – but, you know, still, ultimately, it's going to be inflationary.

And the CPI data this week, as we all saw, the core goods figure definitely beginning to show the tariff impact coming through. It's just good at the moment that we have services disinflation in the housing sector that's offsetting the goods inflation. But, you know, it's still there.

It's still coming through, and there's probably more of that to come. And so, yeah, moving on to that. So, what do you think about the current sort of US positioning in – from their side as opposed from just from the Japanese side?

I mean, there's going to be somewhat pressure from their perspective to start trying to get some stuff over the line and making it more of a success than what it currently is. Do you – what's your current feel on the US strategy? Yeah, like, you know, let's – I guess the whole Fed-Powell firing, that's a podcast in itself.

So, let's put that to the side. But, you know, I think what was interesting this week is we had the capital flow data from the US releases, the Treasury International capital data, and that was for the month of May. So, we did see capital selling by foreign investors of US securities in April.

So, that was Liberation Day month. We did see selling. The question was, was it going to carry through?

Was it going to become a theme or a trend? Well, the answer is no. Big capital, no, because we had basically a record inflow into the US in terms of foreign investor buying of all US securities.

So, private investor purchases of treasuries, agencies, corporate bonds, and US equities was $288 billion, which is by far a single-month record. When you take the 12 months to May, the total is over $1.5 trillion. Again, on a 12-month rolling basis, a record.

So, you know, US exceptionalism, the demise of confidence in the US and the shifting abroad, yeah, it's definitely not in the data. And, you know, we've said definitely that, you know, shifting away from the US is near on impossible given the size of the capital markets. Of course, you can get, you know, moves away, and that is negative for the dollar.

But for us, the more important dynamic is in markets where sentiment is deteriorating, it's not just about the capital flight, it's about protecting your risks. And from an FX perspective, it's about hedging. And when you're talking about $30-odd trillion of US assets held by foreign investors, it's how they manage that exposure is a big issue for FX.

And small shifts in hedge ratios, and you're into trillions of dollars of selling. You know, the big 10% drop in Dollar Taiwan that we had in May was indicative of investors who were under hedged, overexposed in terms of dollar. And I think there's more of that to come.

And given the scale of ownership of US assets, when the Fed starts to cut rates again, which we think will happen before the end of the year, hedging gets cheaper and hedging then will become more prevalent. And I think that flow still has definitely more to run. Good stuff.

Okay. I think we'll leave it there for this week. Great.

Thanks. Have a great weekend. And you, Chris.

Have a good one. Thanks very much. Thank you for listening to this MUFG Global Markets podcast.

Rate, review, and subscribe. Contact your MUFG sales rep for more information. Come back next week for more insights from the Global Markets Research Team.