Takaichi victory increases downside risks for the yen

JPY: Takaichi LDP election win heightens downside risks for yen & JGBs

The yen has weakened sharply during the Asian trading session following the victory for Sanae Takaichi in the LDP leadership election held over the weekend. It has resulted in USD/JPY jumping back above the 150.00-level for the first time since the start of August. On that occasion the move back above the 150.00-level proved to be short-lived whereas the victory for Sanae Takaichi potentially provides stronger justification for a more sustained yen sell-off on this occasion. Her election victory has also triggered outsized moves in the Japanese equity and bond markets. The Nikkei 225 equity index has risen by almost 5.0% while the 30-year JGB yield has risen by around 13bps from Friday’s close lifting it a fresh year to date high. The initial market reaction reflects expectations that Sanae Takaichi will actively pursue looser fiscal and monetary policies to support economic growth in Japan. She is well known as an Abenomics torch bearer and national security hawk which also indicates that the LDP is likely to lurch to more to the right when implementing policies. The Japanese rate market has responded accordingly to pare back expectations for further BoJ rate hikes at the short-end of the curve. The 2-year JGB yield has dropped by around 4bps.

Prior to the LDP election victory for Takaichi, the Japanese rate market was pricing in around 14bps of BoJ hikes for the next policy meeting at the end of this month and 19bps of hikes by the end of this year. However, there are now only around 6bps of hikes priced in by the end of this month and 13bps of hikes by year end highlighting that market participants believe it will now be more difficult for the BoJ to resume rate hikes if Sanae Takaichi puts pressure on the BoJ to slow down policy tightening. Even initial discussions between the BoJ and government may delay plans for a hike as early as this month until there is more clarity from both sides of what is required.                          

In her post-victory press conference, Sanae Takaichi stated “the government and central bank must work closely to ensure the economy achieves demand-driven inflation backed by rising wages and corporate profits”. “It is premature to declare it fully out of stagnation”. “It’s the government that is responsible for fiscal and monetary policies. The BoJ’s roles is to come up with concrete measures that help us to achieve our goals and carry them out”. She stated that demand-pull inflation is “best” and was less supportive of immediate interest rate hikes to address cost-push inflation. She also mentioned revisiting the “Joint Statement” issued by the government and BoJ put in place in January 2013. While it is not the first time that a revision to the “Joint Statement” has been brought up given it is over a decade old, plans to adjust it now that Takaichi is the new leader of the LDP will add to market concerns it may be adjusted to limit the BoJ’s room to continue normalizing policy.      

On fiscal policy, Sanae Takaichi has advocated for “responsible aggressive fiscal policies” and has not rued out the possibility of reducing the consumption tax. She has prioritized measures such as abolishing old provisional tax rates on gasoline and diesel fuel, and raising the basic deduction for income tax. As she seeks a coalition with other political parties in Diet where the LDP no longer has a majority in both the Lower and Upper Houses of the Diet, it appears likely that Japan’s budget position will deteriorate further as they put together another supplementary budget. During the Upper House election, Takaichi was the only leadership candidate who considered increasing the issuance of deficit bonds as unavoidable.  The combination of heightened fiscal risks in Japan and risk of delayed or even derailed BoJ rate hike plans will continue to encourage a weaker yen in the near-term unless evidence emerges that those initial policy expectations will not be realized. It may even open the door to a retest of the year to date highs for USD/JPY in the worst-case scenario although that could prove more challenging now with the Fed continuing to cut rates heading into year end. The weaker yen may also start to attract more attention/criticism from the Trump administration keeping pressure on Japan to continue normalizing monetary policy.   

WEAKER JPY & STEEPER JGB CURVE AFTER TAKAICHI VICTORY

Source: Bloomberg, Macrobond & MUFG GMR

EUR: French political risks in France back in focus weighing on the euro

The other political development in focus at the start of this week has been French President Macron’s decision to appoint a broadly unchanged cabinet. Most senior members from the cabinet of ousted premier Francois Bayrou were renamed to their posts. However, Eric Lombard has been replaced as finance minister by Roland Lescure. The decision to maintain a largely unchanged cabinet have drawn immediate criticism from opposition parties. Even the re-appointed interior minister Bruno Retailleau who leads the centre-right Republicans stated that “the casting of the government does not reflect the promised break with the past”. He plans to hold crisis talks with his party today. The latest development will add to building concerns that new Prime Minister Lecornu will struggle to secure support to pass a budget for next year. He is scheduled to formally outline his policy priorities in a speech to the National Assembly tomorrow, after which Bloomberg reports he could face non-confidence votes as threatened  by opposition groups.

Among Lecornu’s olive branches to opposition parties is a pledge not to use Article 49.3 to bypass votes on financial bills in parliament. He has already outlined he plans to target a budget deficit for next year of 4.7% of GDP which is only slightly higher than the 4.6% target set by former Prime Minister Bayrou. The negative political developments in France have contributed to EUR/USD breaking back below the 1.1700-level. As we have stated previously downside risks for the euro would increase in the near-term if President Macron called a parliamentary election in an attempt to break the deadlock.                   

KEY RELEASES AND EVENTS

Source: Bloomberg & Investing.com