Takaichi Win Jolts Yen and Japanese Bonds, Triggers Stock Surge

Sanae Takaichi speaks during a news conference at the party’s headquarters in Tokyo, Japan, on Oct. 4.

(Bloomberg) -- Pro-stimulus lawmaker Sanae Takaichi’s near-certain elevation as Japan’s next prime minister jolted financial markets, with the yen and long-term bonds tumbling even as equities surged to all-time highs.

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The politician’s surprise victory in a ruling party leadership vote at the weekend reduced expectations that Bank of Japan may hike interest rates as soon as this month while raising worries about more debt supply to finance stimulus.A screen displays the Nikkei 225 Stock Average and rising share prices in Tokyo on Oct. 6.Photographer: Kiyoshi Ota/Bloomberg

“Takaichi’s election as leader of Japan’s ruling party is being interpreted as a clear positive for risk assets,” said Dilin Wu, a strategist at Pepperstone Group Ltd. “Investors are actively balancing the potential upside of stimulus against bond market risk, quickly adjusting positions to navigate possible currency swings.”

The yen lost 1.8% against the dollar to past 150 and sank to an all-time low against the euro. Longer-term bonds fell on concern Takaichi’s policies will require more government spending and fan inflation. The 40-year yield surged as much as 17 basis points to 3.55%, and that on the benchmark 10-year bond rose to 1.68%, the highest since 2008.

Yields on Japan’s two-year notes moved in the opposite direction to those on long-term bonds, dropping 4 basis points to 0.9%.

Traders rushed to recalibrate the chances of a BOJ rate hike at its Oct. 29-30 meeting. Overnight index swaps priced in about a 24% chance of an increase, down from 60% before the Liberal Democratic Party’s leadership vote.

“Sanae Takaichi’s surprise victory in the LDP leadership election marks an important turning point for Japan’s policy and market outlook,” Societe Generale strategists wrote in a note, pushing back the likely timing of the BOJ’s next rate hike to December from October.

“Her remarks do not point to an immediate or large-scale fiscal expansion, but her policy orientation and past record suggest a willingness to use fiscal levers actively to support growth if needed,” they wrote.

What Bloomberg strategists say...

The selloff for the yen is broad based, with EUR/JPY reaching a record high and Japan’s currency sliding back toward the lowest levels seen on a trade-weighted basis. FX traders will be on alert for Japanese officials to jump in with verbal intervention to slow the declines.

— Mark Cranfield, Markets Live strategist. Click here for the full analysis.

Story Continues

Hopes of more fiscal spending lifted stocks, with the Nikkei 225 Stock Average closing 4.8% higher at a fresh record. Shares of exporters, such as automakers, gained on a weakening yen. Defense equipment manufacturers and some construction companies also rose sharply on speculation Takaichi, an energetic nationalist, may favor spending in these industries.

Domestic demand-oriented stocks and small caps may get a boost on growth expectations, but banking shares, which had gained on rate hike speculation, may struggle, said Richard Kaye, co-head of Japan equity strategy at Comgest Asset Management.

Takaichi is poised to become Japan’s first female prime minister after winning the LDP leadership contest on Saturday. Investors had expected the seat to go to political scion Shinjiro Koizumi, who was seen as taking a more fiscally cautious view and leaving the BOJ to press ahead with normalization.

Bond investors had been wary of fiscal spending even before Takaichi’s win, with opposition parties calling for tax cuts. A 30-year bond sale on Tuesday is seen as a litmus test for investors’ appetite.

“The bond market will want to see that Takaichi’s pro-growth strategies don’t widen the public sector deficit,” which would also likely encourage yen selling, said Pelham Smithers, managing director at UK-based Japan equity research firm Pelham Smithers Associates. “However, yen bulls may point to the BOJ’s increased likelihood of offsetting any increased fiscal stimulus with more aggressive monetary tightening.”

Takaichi, who said lifting interest rates would be “stupid” during her LDP leadership run last year, has toned down her rhetoric this time around. In a recent Kyodo survey however, she still said the BOJ should leave interest rates unchanged for now.

“While not as clearly demonstrated as in last year’s leadership election, the market perceives that fiscal discipline will loosen and that she will not show much understanding for BOJ rate hikes,” said Katsutoshi Inadome, a senior strategist at Sumitomo Mitsui Trust Asset Management Co. “Pricing in for an October rate hike will likely retreat somewhat.”

In the stock market, sectors such as artificial intelligence, technology and industrials may benefit given Takaichi’s interest in strategic investment in these spaces, according to Anna Wu, cross-asset investment strategist at VanEck Australia. The auto sector may rally if she successfully renegotiates the terms of the US-Japan trade deal and seeks further clarity or concessions on the industry, Wu said.

Takaichi is expected to be elected prime minister in a parliamentary vote this month. Attention now turns to the makeup of the next cabinet and how the LDP will work with the opposition.

--With assistance from Kentaro Tsutsumi, Masahiro Hidaka, Hidenori Yamanaka, Brian Fowler, Naoto Hosoda and Winnie Hsu.

(Updates bond yields, closing level for stocks.)

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