Japanese media reports suggest that Prime Minister Shigeru Ishiba’s government risks losing its majority. This weekend’s upper house by-elections are seen as a test for Ishiba’s leadership and his minority government, which partners with Komeito.
The government is grappling with falling approval ratings, alongside rising public concern over living costs and economic issues. Although it is unlikely that the ruling coalition will lose power entirely, poor election results could undermine Ishiba’s position.
Opposition And Economic Policies
The opposition, campaigning for tax cuts and increased fiscal stimulus, might gain momentum if results favour them. Election outcomes could influence economic policies, budget talks, and the power balance in the Diet.
This could lead to market impacts if spending-focused or populist policies gain traction. Nikkei has highlighted these concerns, noting the vulnerability of Ishiba’s coalition in the current political setting.
We see the political tremors in Tokyo not as a risk, but as a distinct and mispriced opportunity. The market appears to be sleepwalking into this weekend’s by-elections, and we believe it’s time to position for a spike in volatility. With Ishiba’s cabinet approval rating recently plummeting to a dismal 25.7% in a Kyodo News poll, the lowest for his administration, the potential for a political upset is far more tangible than current derivative pricing suggests. This isn’t just political theater; it’s a direct catalyst for monetary and fiscal policy shifts.
Market Strategy And Implications
The Nikkei Volatility Index, the VXJ, has been hovering around a relatively subdued 17. This is cheap insurance. We see this as a clear signal to buy volatility ahead of the results. Any sign that Ishiba’s coalition is losing its grip will embolden the opposition and their calls for more aggressive fiscal stimulus. Historically, as we saw with the market reaction to the massive stimulus programs of the past decade, this kind of policy direction is unequivocally negative for the yen and positive for equities. A weak showing for the ruling coalition could easily push the USD/JPY pair through the critical 160 level, a psychological barrier the Ministry of Finance has been desperately trying to defend.
Our strategy is therefore focused on options. We are not betting on a specific direction but on the fact that the outcome will force a significant move. A weaker government means more spending, delaying any real hawkishness from the Bank of Japan as it battles inflation that remains stubbornly above its 2% target, with core CPI hitting 2.5% in May. This scenario favors long Nikkei 225 calls and long USD/JPY calls. Conversely, a surprise show of strength by the ruling coalition could be interpreted as a mandate for fiscal discipline, giving the Bank of Japan the political cover it needs to proceed with normalization, which would trigger a sharp yen appreciation and knock the Nikkei.
Given these two divergent paths, a simple long straddle on Nikkei futures or a strangle on the USD/JPY is the textbook play. It allows us to profit from a large price swing in either direction. The market has given us a gift with low implied volatility just days before a known event that has the power to dramatically alter Japan’s economic trajectory.
