Initial Thoughts on Japan's Election
The outcome of Japan's election seems to be largely in line with market expectations. The Liberal Democrat Party won handily. It appears to have secured a majority of lower chamber of the Diet.
There had been some reports suggesting that it might be able to achieve a super-majority of 2/3, but this does not look to materialized. However, with its traditional party, the Komeito, together it may.
In any event, this is a strong mandate for the LDP's agenda. It is a combination of nationalism and what passes for socialism in the neo-liberal age, namely increased government support for the economy via 1) massive public spending and 2) unlimited monetary easing.
Facing territorial disputes with China (among others) and North Korean missile development, the LDP advocate amending its pacifist constitution. For this the LDP may also count of support from the Restoration Party, which may have been one of the big winners of the election.
The Resortation Party began off as a small regional party in Osaka and its members of parliament were largely defects from other parties and have emerged this time as the third largest party in Japan, not far behind the DPJ.
The leader of the Restoration Party is none other than the previous governor of Tokyo (Ishihara) who instigated the purchase of the disputed islands, which was done in a clumsy way and spurred an undesirable but not unpredictable China's retaliation. The real founder of the party is a princeling (Hashimoto) who will remain mayor of Osaka. Ishihara is now in the Diet and will have an increasingly national voice.
As noted in our review of the positioning in the futures market, the short-term speculative market has amassed a very large short yen position. Outside of the 2005-2006 period, a hey day of using the yen as a funding currency (yen carry trade, a source of leverage in the latter stages of the credit cycle), the gross and net short yen position in the futures market is extreme.
The Japanese stock market has been a big beneficiary of the decline in the yen. This makes sense and is in line with long-term historic relationships. What is, perhaps, most surprising, in the recent price action is the fact that the JGB market has held up so well. Little sign of investor concern that the new government will pursue aggressive monetary and fiscal policies that are designed to push up inflation and inflation expectations.
Currency traders and equity investors are not resisting the likely thrust of policy. The debt market seems to be. Even the CDS pricing shows no heightened concern.
The first instinct for many may be to sell the yen on the news and ahead of the BOJ meeting. The BOJ is expected to extend its asset purchase program (QE). However, given the magnitude of the recent move and positioning, we cautious about chasing the market before a correction.