Markets likely mispricing Japans Takaichi trade

In the days since its landslide victory, Sanae Takaichi’s Liberal Democratic Party finds itself grappling with the ultimate political quandary: what to do when you’re the proverbial dog that caught the car?

The yen’s powerful rally since Sunday’s election triumph suggests markets are thinking twice about the aggressive fiscal loosening Japan’s first female leader promised on the campaign trail.

Takaichi, who took office on October 21, pledged to boost gross domestic product, accelerate wage gains and ensure that Japan’s stock market continues to hit record highs.

But her strategy to do so calls for a gimlet eye view of what’s ahead for Asia’s second-biggest economy.

There’s no doubt that Takaichi has a mandate for sweeping change. And Japan desperately needs it, as China expands not just its regional dominance but also its global status.

The expectation to date has been that Takaichi will, in short order, double down on the extreme monetary and fiscal policies of her now-deceased mentor Shinzo Abe.

Unsurprisingly, the “bond vigilantes” are concerned, having seen this movie too many times before. Odds are good that a weaker yen now will only further deaden Japan’s animal spirits, while adding to Tokyo’s massive debt.

Takaichi bet big on the February 8 snap election — and won bigger than just about anyone expected, with the LDP’s margin of victory bigger than for any party since World War II. With a clear electoral mandate, Japan’s first female leader faces few political obstacles.

“Politically, the win hands… Takaichi freedom of movement and removes the need to bargain every decision down to the lowest common denominator,” says SPI Asset Management economist Stephen Innes.

What’s changed, though, is that many think Takaichi will now throttle back on her earlier bold talk of opening the fiscal floodgates to hasten economic growth.

“(We) view the recent fiscal expansion as an attempt to bolster public support ahead of the election rather than as a sign of things to come,” says economist Marcel Thieliant at Capital Economics. “With Upper House elections not due until 2028, we don’t expect any further major fiscal loosening.”

Economist Sree Kochugovindanat Aberdeen Investmentstells CNBC that the LDP landslide does notentitleTakaichi“free rein to just spend. The LDP is fiscally conservative, and Takaichi has been very mindful of bond investors.”

Trouble is, Takaichi has articulated no plans to cut bureaucracy, make labor markets more meritocratic, rekindle innovation, increase productivity, narrow the gender pay gap, or re-establish Tokyo’s place at the center of Asia’s financial and technological universes.

Much of the rationale behind the “Takaichi trade” is the expectation that she will launch Abenomics 2.0. Yet here, too, it’s worth separating myth from economic reality.

In his nearly eight-year premiership from 2012 to 2020, Abe talked a big game of reviving Japan’s animal spirits. Mostly, though, he ramped up monetary and fiscal stimulus to juice the economy.

His successes—such as prodding companies to tighten corporate governance—did nothing to raise average households’ wages or increase economic efficiency.

Takaichi must do better, of course. But employing the same playbook gives investors valid reasons to doubt her sincerity in recalibrating Japan’s growth engines and improving competitiveness.

It follows, then, that they have every reason to worry that opening the fiscal floodgates will cause a revolt among bond traders and investment funds.

“Abenomics was done at the time of deflation in Japan and a higher yen,” notes Hiroshi Shiratori, a professor at Hosei University. “Now is the time of inflation, and the cheaper yen exacerbates inflation, with the market reacting to worries over the potential worsening of fiscal conditions.”

Frederic Neumann, chief Asia economist at HSBC, argues that the “strong LDP win is warming the hearts of investors.” Equities, in particular, “are celebrating the surprising election result, re-loading the ‘Takaichi-trade.’ The hope is that the strong majority will give the LDP more leeway in pursuing growth-friendly policies.”

Odds are high that the yen is headed lower and that Japanese government bond (JGB) yields will rise.

“The market will be watching the PM’s statements and the progress of JGB auctions carefully in the months ahead for any signs of wobbles,” says Jane Foley, foreign exchange strategist at Rabobank.

All this still has markets buzzing about a possible “LizTrussmoment” in Japan. “The dynamics,” says Jeroen Blokland, founder of the Blokland Smart Multi-Asset Fund, “arestarting to look uncomfortably similar to those in the UK in 2022.”

That’s when Truss—who would go on to become the shortest-serving UK prime minister in modern history—announced an unfunded tax cut package.

RobinBrooks, economist at the Brookings Institution, notes that “I’ve been flagging for a long time that we’re in the early stages of a global debtcrisis. Long-term government bond yields have risen sharply everywhere. Markets are losing patience with governments that are chronically unable or unwilling to reduce public debt. This is no time to pretend Japan’s humongous debt isn’t a problem. Denial isn’t a plan.”

Yet denial abounds, prompting the so-called bond vigilantes to signal to Team Takaichi that Tokyo has limited latitude for fiscal and monetary pump-priming.

With a debt-to-GDP ratio as high as 260% and a fast-shrinking national population, the market could keep Team Takaichi on a tight leash.

One worry is that the Takaichi government doesn’t seem to have internalized the lessons from 26 years of zero interest rates.

A weak yenhas removed the urgency to level the playing field and increase competitiveness. It explains why Tokyo is watching with alarm as Chinese electric-vehicle maker BYD and artificial-intelligenceupstart DeepSeek reshape the global market the way Japan Inc. did in the 1980s.

This is all greatly challenging the Bank of Japan’s year. Of course, the BOJ has grown used to the Japanese government not doing its job.

Since 1999, when the BOJ first cut rates to zero, one government after another has come and gone without major economic improvements.

Unless Takaichi takes bold steps to level playing fields and shift regulatory and tax priorities toward startups to disrupt Japan Inc, ultralow rates have zero chance of raising its competitive game.

Takaichi looks to be the latest Japanese leader to let the BOJ take the lead and to switch Tokyo’s fiscal-spending machine back on.

Even economists and investors giving Takaichi the benefit of the doubt so far worry that her team isn’t doing a great job detailing its plans to markets.

Economist Takeshi Yamaguchi at Morgan Stanley MUFG says that even though Takaichi’s announcement that she is considering eliminating the consumption tax on food products “came as a surprise to us and undeniably had a negative impact in terms of policy predictability and stability, it appears that her intention not to widen the fiscal deficit has not been fully conveyed to investors.”

Yet investors have ample reasons to doubt theLDP’s assurancesthat debt isn’t about to explode. Or that the yen isn’t heading to 160 to the dollar or even lower.

To date, this is the only substantive strategy Takaichi has articulated. Markets might be wise to question the new conventional wisdom that Takaichi won’t hit the debt accelerator just because she says she won’t.

Follow William Pesek on X at @WilliamPesek