Japan experienced a political earthquake on Sunday. Prime Minister Shigeru Ishiba’s ruling coalition suffered a major defeat in the upper house elections — an outcome investors had already priced in. While the result wasn't entirely unexpected, it comes at a delicate moment: the country is facing tariff threats from the U.S. while trying to stabilize its domestic economy.

Preliminary estimates suggest the coalition has lost control of the upper house and, for the first time in years, will hold a minority in both houses of parliament.

💱 Markets Reacted in Advance

Although Japan’s markets were closed on Monday due to a holiday, investors began repositioning for risk last week.

🔹 The yen weakened against both the U.S. dollar and the euro.

🔹 Yields on 30-year Japanese government bonds surged to record highs.

🔹 Japan’s fiscal health remains fragile, and the deficit is likely to deepen.

“I won’t chase the coalition’s losing trades,” said Rong Ren Goh, a portfolio manager at Eastspring Investments. He noted that markets are now focused on U.S.-Japan trade talks, which could pose a major risk for Japan.

🧩 A Weakened Coalition Looks for a Path Forward

It remains unclear whether the ruling LDP will try to govern as a minority or seek a new coalition partner. One possibility is a pact with the Democratic Party for the People (DPP), which advocates for looser monetary policy and tax cuts in exchange for support.

Prime Minister Ishiba has so far rejected calls to step down, but internal party discussions are already underway. His likely successor? Sanae Takaichi, a proponent of Abenomics and further easing by the Bank of Japan.

💸 Taxes, Bonds, and a Growing Deficit

All three major opposition parties back lowering the consumption tax. The right-wing Sanseito party even proposes abolishing VAT entirely. But these measures would require more debt — a lot more.

With a national debt equivalent to 2.5 times GDP, Japan remains the most indebted advanced economy in the world.

Barclays analysts estimate that a 5% tax cut would push 30-year bond yields up by 15–20 basis points.

Even before the elections, Japan’s bond market was under pressure — long-term yields have risen by nearly 1% over the past year. Debt service costs now account for around 12% of the government’s revenue.

📉 Yen and Nikkei: Two Sides of the Same Coin

The yen traded between 140 and 160 per dollar in H1 2025. It spiked after the BoJ raised rates in January, but has remained flat since late April due to political uncertainty, tariff negotiations, and the BoJ’s cautious approach.

Traders are heavily positioned long yen, so any unexpected developments — snap elections, new leadership, or fiscal loosening — could trigger sharp declines.

On the other hand, the Nikkei 225 index is rising — since April 2, when President Trump unveiled his global tariff plan, it has gained over 11%. While the yen weakens, equities — for now — reflect optimism about stimulus and fiscal support.

🧠 One-Minute Summary

Japan is entering a period of heightened political instability. The ruling coalition has lost the upper house, putting planned reforms at risk. Markets had partially anticipated this, adjusting in advance. Now the focus shifts to key questions: Will Ishiba stay? Will there be a new coalition? And how will Trump respond if Japan misses the August 1 tariff deadline?


#JapanEconomy , #Politics , #economy , #GlobalMarkets , #Geopolitics

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