Liberal Democratic Party's election victory rekindles the yen's rise; Takashi's new policies trigger policy uncertainties

The Bank of Japan’s rate hike expectations are rising, coupled with the Liberal Democratic Party’s overwhelming victory in the elections, driving recent strength in the Japanese yen. After the House of Representatives election results were announced on February 9, the ruling coalition formed by the LDP and Nippon Ishin won 352 seats (out of 465), paving the way for Prime Minister Fumio Kishida’s policy agenda. This political shift immediately boosted Japanese stocks, caused sharp fluctuations in the yen, initially weakening it, then rapidly rebounding, indicating the market’s complex expectations for future policy directions.

How does political victory drive the yen higher?

The LDP’s landslide victory further consolidates the so-called “Koshi trading” framework—the coordinated effect of rising Japanese stocks, increasing Japanese bond yields, and a weakening yen. However, this time is different; after an initial depreciation, the yen quickly reversed and strengthened, showing that the market is beginning to price in new risk factors. The Nikkei 225 index rose over 5%, surpassing 57,000 points to hit a record high, but the yen moved in the opposite direction, reflecting investors’ reassessment of policy space.

Bloomberg strategist Mark Cranfield said that the LDP’s election victory under Fumio Kishida could prompt Japanese authorities to more actively defend the yen exchange rate. “The market should no longer expect that continued shorting of the yen will go smoothly. Macro traders are closely watching for signs of government intervention, especially any coordinated actions between Japan’s government and the central bank, which are currently undervalued in the forex market.”

“Koshi trading” faces government intervention and central bank policy tests

Whether the yen’s rally can continue depends on two key policy signals. MUFG and Morgan Stanley FX strategist Daisaku Ueno pointed out that once USD/JPY approaches the 160 level, market vigilance for intervention will significantly increase, and further yen depreciation will be severely limited.

Currently, the market’s focus centers on two core issues: first, whether Fumio Kishida will truly implement his promised consumption tax cuts. If he swiftly pushes for tax reductions after taking office, it could increase downward pressure on the yen, conflicting with the current upward trend. Conversely, if he adopts a cautious stance, the pressure for yen depreciation may ease, allowing the rally to continue. Second, the direction of the Bank of Japan’s monetary policy will directly influence the yen’s long-term trend.

Rate hike expectations versus Federal Reserve policy tug-of-war

The overnight index swap market currently indicates about a 75% probability that the Bank of Japan will raise interest rates by 25 basis points at the April meeting. This high probability reflects market expectations of a clear rate hike trajectory in Japan, but actual implementation remains uncertain. If Japan’s rate hike expectations further intensify, combined with the Fed maintaining a relatively dovish stance, the yen could continue to strengthen. Conversely, if rate hike expectations in Japan weaken or the Fed’s easing expectations rise, the USD/JPY could reverse lower, reversing the yen’s rally.

The key policy decision date is March 19, when both the Bank of Japan and the Federal Reserve will announce their latest interest rate decisions simultaneously. The outcome of this meeting will have a significant impact on the global forex market, especially the medium-term direction of USD/JPY. Investors should closely monitor the Kishida government’s stance on consumption tax policy, the central bank’s rate hike signals, and the Fed’s policy tilt—these three factors will determine whether the yen’s rally can sustain over the coming months.