Japan election result to encourage further JPY selling

JPY: Intervention risk is helping to dampen sell-off after election

It has been a volatile trading session for the yen overnight following the crushing election victory for the ruling government in the lower house election at the weekend. The yen initially weakened lifting USD/JPY up to a high of 157.76, but has since reversed all of those gains falling back to a low of 156.22. The election victory has also triggered a powerful rally in the Japanese equity market which has risen to fresh record highs. The Nikkei 225 index has increased by around 4%. In contrast, there has been further selling of Japanese government bonds. The yield on the 2-year and 10-year JGBs have increased by around 3bps and 6bps respectively while the 30-year yield is currently flat on the day. The yen  initially weakened after it was confirmed that Prime Minister Takaichi’ decision to call a snap election paid off big time giving her a strong mandate to continue implementing her “reflationist policy agenda”. The LDP secured 316 seats giving it a higher proportion of representatives  in the lower house than any other party in post-war Japan. The LDP has secured a two-thirds super majority by itself, and a combined total of 352 seats out of 465 in the lower house alongside their coalition partner Japan Innovation Party. A super majority in the lower house will make it even  easier for her coalition to pass legislation. It means any bills rejected by the upper house, where the coalition doesn’t have a majority, could be overridden and passed again in the lower house.

After the decisive election victory. Prime Minister Takaichi indicated that she’d like to proceed on the promise that she had won public approval for a suspension of the food sales tax for two years without issuing fresh government bonds to finance the additional cost estimated at around JPY10 trillion. But noted that given the difference of opinion among political parties, discussions were still required. She stated specifically that “the consumption tax is an extremely significant issue. We intend to proceed flexibly, listening to the opinions of each party, while we aim to reach a conclusion as soon as possible”. The comments still leave some wiggle room to amend her plan, and the continuing ambiguity perhaps reflects an awareness that the JGB market and the yen reacted negatively to the plan when it was first announced. At the same time, the super majority has opened up the possibility of making changes to Japan’s constitution. She would like to see a parliamentary debate on the issue of reviving Japan’s 1947 constitution, potentially including it’s “peace clause”. The constitution has never been amended and any attempt could only be made by a government with a super majority. However, it would still be challenging to make constitutional amendments as it requires approval by a two-thirds majority in both the lower and upper houses, and then a majority must be obtained in a national referendum.                                 

Yen weakness following the election result has been constrained by the heightened risk of intervention as USD/JPY moves back into the high 150.00’s. Japan’s top currency official Atsushi Mimura warned that they are watching market moves with a high sense of urgency. It followed comments from Finance Minister Satsuki Katayama who said after the election victory that she will communicate with financial markets on Monday if needed. She reiterated that “Japan and the Us have signed a memorandum of understanding, which stated that we can take decisive measures against rapid movements out of line with fundamentals. That certainly includes intervention”.  The ongoing threat of intervention has helped to dampen further yen selling after the lower house election although it remains vulnerable to further weakness if market participants remain concerned over policy direction going forward under Prime Minister Takaichi. The release of the latest IMM positioning report on Friday revealed that Leveraged Funds had been scaling back short yen positions in response to growing unease over intervention risk. Yen short positions had been cut back for three consecutive weeks and by almost half.        

SHORT JPY POSITIONS HAD BEEN CUT BACK AHEAD OF ELECTION

Source: Bloomberg, Macrobond & MUFG GMR

GBP: UK political risks continue to weigh on pound

The pound is continuing to trade on a weaker footing at the start of this week extending the sell-off from last week. After hitting a low last week at 0.8613, EUR/GBP has risen back above the 0.8700-level and threatening to move higher at the start of this week. The reversal weaker for the pound has been driven both by the dovish repricing of BoE rate cut expectations (click here), and by renewed concerns over political risks in the UK. Keir Starmer’s position as prime minister suffered another blow over the weekend after his chief of staff Morgan McSweeney took “full responsibility” for the decision to appoint Peter Mandelson as the US ambassador and resigned. According to media reports over the weekend, Labour MPs are now openly speculating about how long Sir Starmer can continue in power. His position has been described as “untenable”. Sir Starmer was reportedly drawing up plans for an emergency address to the nation to set out plans to clean up politics. He is expected to address MPs today at a meeting of the Parliamentary Labour party. The pick-up in UK political uncertainty has arrived earlier than we had anticipated triggered by the Epstein scandal. It supports our current long AUD/GBP trade recommendation (click here), and could yet trigger a sharper pound sell-off if there is a leadership challenge       

KEY RELEASES AND EVENTS

Source: Bloomberg & Investing.com