Japan's political "earthquake"! Yen weakens, Japanese bonds are sold off, and the market bets that the Bank of Japan may delay interest rate hikes

According to Zhitong Finance APP, the Japanese market is facing turmoil after Prime Minister Shigeru Ishiba announced his resignation due to setbacks in the second election. In early trading on Monday, the yen fell by as much as 0.7% against the US dollar, having previously been the weakest among the G10 currencies in the past week. The stock market is subject to multiple influencing factors, making volatility inevitable. Given the heightened concerns over government spending, long-term Japanese government bonds are particularly susceptible to selling pressure at the market's opening.

Despite the poor performance of Ishiba's ruling party in the July elections, it was anticipated that he would eventually step down. However, traders are still trying to determine how much fiscal stimulus measures Ishiba's potential successor will implement and to what extent any changes will delay the Bank of Japan's next interest rate hike.

A significant rise in Japanese government bond yields would pose a threat to global markets. Previously, global markets have remained vigilant about the potential spillover of Japan's debt crisis to European and US bond markets. As fiscal concerns in major economies have reignited, long-term bond yields have continued to rise.

Nick Twidale of ATFX Global Markets believes that due to the current political environment, the Bank of Japan may abandon its interest rate hike plans this year. Twidale stated that the yen will "experience significant volatility, making trading more difficult. Interest rate traders will also face higher risks."

The swap market indicates that the Bank of Japan is unlikely to take action at its policy meeting later this month. The market has fully priced in that the Bank of Japan will not raise interest rates until April next year, with the likelihood of a rate hike before the December meeting this year slightly below 50%.

Market views on the Japanese stock market are mixed. Typically, the Japanese stock market would benefit from more fiscal stimulus measures and a weaker yen.

Here are the views of strategists and analysts on the outlook for the Japanese market:

Michael Brown, Senior Research Strategist at Pepperstone:

"Realistically, this event will undoubtedly have a significant adverse impact on the yen and long-term Japanese government bonds. We not only need to consider the substantial increase in political risks during the Liberal Democratic Party leadership campaign but also the risks associated with a new leader holding elections. Both scenarios are likely to lead to increased fiscal spending as the spending taps are reopened to attract voters in any polls."

"All of this could lead the Bank of Japan to maintain interest rates for a longer period, as they will continue to adopt extremely cautious policy tightening measures. Policymakers may want to observe how the latest political situation develops before deciding whether to raise rates further."

"The developments will certainly not improve the already weakened demand for bond auctions. This means there will be many concerns... but more importantly, it means that the weakness of long-term bonds and the steepening of the yield curve are unlikely to change in the short term."

"To be honest, it's somewhat similar to the situation in the UK—demand for Japanese government bonds has always existed; the question is how high the yield premium participants demand when purchasing. With Ishiba's impending departure, the yield premium will only be higher."

Katsutoshi Inadome, Senior Strategist at Sumitomo Mitsui Trust Asset Management: "Shinzo Abe's resignation will trigger selling pressure in the bond market, especially in ultra-long-term bonds. He is known for his strict fiscal discipline. While it is currently unclear who will become the next Prime Minister, it is hard to imagine anyone who could do better than him in terms of fiscal discipline, or even match him. Due to concerns about fiscal matters, the weak performance of ultra-long-term bonds is likely to persist and may even worsen."

"If the next Prime Minister is not as tolerant of interest rate hikes by the Bank of Japan as Shinzo Abe was, 'then it could be someone who opposes rate hikes, which could lead to a decline in medium-term government bond yields.'"

"Long-term rates may rise in sync with ultra-long-term bond yields. The yield curve is expected to steepen."

"Potential candidates for the next Prime Minister include Shinjiro Koizumi, Yoshimasa Hayashi, and Sanae Takaichi. If Shinjiro Koizumi or Yoshimasa Hayashi wins, the situation is unlikely to be too chaotic, and the yield curve may return to its previous shape. If Sanae Takaichi wins, the bond sell-off may intensify due to the risk of a credit rating downgrade."

"We expect a triple decline scenario—falling bond and stock prices, along with a depreciating yen."

Ken Matsumoto, Macro Strategist at Crédit Agricole:

"Our main prediction is that Sanae Takaichi will replace Shinzo Abe, and she is generally considered to hold a dovish stance on both monetary and fiscal policy."

"The market seems to have already digested this factor, as evidenced by the rise in ultra-long-term bond yields." However, based on initial reactions, long-term bond yields may rise further, while short-term bond yields may decline.

"Shinjiro Koizumi is relatively neutral, so if he wins, the situation may improve. Yoshimasa Hayashi is more inclined towards fiscal tightening policies, so if he wins, it may bring a more pronounced suppressive effect. However, his close relationship with Shinzo Abe makes us believe that his chances of winning are slim."

Jumpei Tanaka, Head of Investment Strategy at Pictet Asset Management Japan:

"In the Japanese stock market, due to the easing of political uncertainty, a brief rise in the stock market is expected. After that, the market focus may shift to who will become the next Prime Minister. If Sanae Takaichi, who supports active fiscal policy, is elected, concerns about fiscal discipline may put downward pressure on the yen, and the yen's decline may support the Japanese stock market, especially export-related stocks."

Hiroshi Namioka, Chief Strategist at T&D Asset Management:

"The Japanese stock market is expected to decline at the opening, partly due to the impact of U.S. employment data. Concerns about fiscal easing are expected to push up Japan's ultra-long-term interest rates."

"As for the USD/JPY exchange rate, while considering the weakness of the U.S. economy, concerns about Japan's political situation and the stagnation of the normalization process of monetary policy are likely to lead to sideways fluctuations or temporary depreciation of the yen."

Neil Newman, Chief Strategist at Astris Advisory Japan: "Generally speaking, political factors have little short-term impact on market trends, but strong leadership and policies can indeed have a long-term effect, as demonstrated by Prime Minister Abe over the years. Prime Minister Shigeru Ishiba's decision to make way for a successor is a positive change."

"Japan's economy is expected to achieve significant growth in the coming years, and the right new leadership will support long-term growth."

"A young successor or a female prime minister leading the country would be seen as a very positive development."

IG Sydney analyst Tony Sycamore:

The news of Shigeru Ishiba's resignation is "not surprising" following the announcements of resignation intentions from Liberal Democratic Party Secretary-General Hiroshi Moriyama and other party officials.

"However, this will increase pressure on the yen and Japanese government bonds before October 4, as that date is seen as the most likely for the election of a new leader. If the market begins to feel that a dovish candidate is more favored, this pressure will be even greater."

The USD/JPY exchange rate could "rebound to the level of 149.10." As of the time of writing, the USD/JPY exchange rate is 148.21