Japan election preview: What a big LDP win could mean for the economy, bonds and the yen | articles

It has been a volatile start to the year for USD/JPY, and it looks set to continue. The prevailing investment thesis has been that a negative real policy rate in Japan, burgeoning fiscal challenges and global investors favouring pro-cyclical currencies are all weighing on the yen. What seemed to be Japanese FX intervention near 160 and then reports of a Fed rate check late on Friday, 23 January have been the sole positives for the yen. Yet some official denials of US involvement and subsequent Japanese data question whether intervention took place at all. On the subject of intervention, we wonder whether strategic investment decisions from some of the government-influenced pension funds may be playing a role here – as is also the case in Korea when USD/KRW approaches 1500.

A positive election result for the LDP that would pump more air into the ‘Takaichi trade’ is a USD/JPY positive. USD/JPY could even approach 160/162 levels again on the back of this. Officials in Tokyo have made it clear they are uncomfortable with those kinds of levels, which, while good for exporters, also stand to increase import prices at a time when the government is trying to ameliorate the cost-of-living crisis. Therefore, FX intervention near 160/162 looks likely.

Will intervention be effective? Effective intervention requires heavy one-way market positioning and a turn in the fundamentals. Intervention proved effective in July 2024 when the speculative market was extremely short yen and the Fed was about to embark on an easing cycle – which the Fed did with a 50bp cut in September that year. USD/JPY fell from 160 to 140 over that two-month period.

Today, speculative positions are nowhere near as short yen as they were in 2024. And with the Fed funds rate now much closer to neutral at 3.75%, the prospect of lower short-dated US rates is far less compelling than it was two years ago. In short, the conditions are not in place today for a large correction lower in USD/JPY.

Instead, it looks like an LDP-inspired push higher in USD/JPY (assuming polls prove correct) will spark a sustained intervention campaign that could potentially last for the remainder of this year. For reference, the BoJ sold $100bn over four separate days between May and July in 2024. And in addition to the yen negatives discussed above, there is also the uncertainty about the timing of Japan’s commitment to invest $550bn into the US – and whether that gets funded with dollar instruments (probably) or whether any FX flows are involved.

In all, we forecast USD/JPY to bounce around in a 155-160 range through the first half of the year and then 50bp of Fed rate cuts to drag it closer to 150 by year-end. But upside risks prevail for the rest of this quarter.