Markets Likely Mispricing Japan's 'Takaichi Trade'

Economist Sree Kochugovindan at Aberdeen Investments tells CNBC that the LDP landslide does not entitle Takaichi“free rein to just spend. The LDP is fiscally conservative, and Takaichi has been very mindful of bond investors.”

Trouble is, Takaichi has articulated no plans to cut bureaucracy, make labor markets more meritocratic, rekindle innovation, increase productivity, narrow the gender pay gap, or re-establish Tokyo's place at the center of Asia's financial and technological universes.

Much of the rationale behind the“Takaichi trade” is the expectation that she will launch Abenomics 2.0. Yet here, too, it's worth separating myth from economic reality.

In his nearly eight-year premiership from 2012 to 2020, Abe talked a big game of reviving Japan's animal spirits. Mostly, though, he ramped up monetary and fiscal stimulus to juice the economy.

His successes-such as prodding companies to tighten corporate governance-did nothing to raise average households' wages or increase economic efficiency.

Takaichi must do better, of course. But employing the same playbook gives investors valid reasons to doubt her sincerity in recalibrating Japan's growth engines and improving competitiveness.

It follows, then, that they have every reason to worry that opening the fiscal floodgates will cause a revolt among bond traders and investment funds.

“Abenomics was done at the time of deflation in Japan and a higher yen,” notes Hiroshi Shiratori, a professor at Hosei University.“Now is the time of inflation, and the cheaper yen exacerbates inflation, with the market reacting to worries over the potential worsening of fiscal conditions.”

Frederic Neumann, chief Asia economist at HSBC, argues that the“strong LDP win is warming the hearts of investors.” Equities, in particular,“are celebrating the surprising election result, re-loading the 'Takaichi-trade.' The hope is that the strong majority will give the LDP more leeway in pursuing growth-friendly policies.”

Odds are high that the yen is headed lower and that Japanese government bond (JGB) yields will rise.

“The market will be watching the PM's statements and the progress of JGB auctions carefully in the months ahead for any signs of wobbles,” says Jane Foley, foreign exchange strategist at Rabobank.

All this still has markets buzzing about a possible“Liz Truss moment” in Japan.“The dynamics,” says Jeroen Blokland, founder of the Blokland Smart Multi-Asset Fund,“are starting to look uncomfortably similar to those in the UK in 2022.”

That's when Truss-who would go on to become the shortest-serving UK prime minister in modern history-announced an unfunded tax cut package.

Robin Brooks, economist at the Brookings Institution, notes that“I've been flagging for a long time that we're in the early stages of a global debt crisis. Long-term government bond yields have risen sharply everywhere. Markets are losing patience with governments that are chronically unable or unwilling to reduce public debt. This is no time to pretend Japan's humongous debt isn't a problem. Denial isn't a plan.”

Yet denial abounds, prompting the so-called bond vigilantes to signal to Team Takaichi that Tokyo has limited latitude for fiscal and monetary pump-priming.

With a debt-to-GDP ratio as high as 260% and a fast-shrinking national population, the market could keep Team Takaichi on a tight leash.

One worry is that the Takaichi government doesn't seem to have internalized the lessons from 26 years of zero interest rates.

A weak yen has removed the urgency to level the playing field and increase competitiveness. It explains why Tokyo is watching with alarm as Chinese electric-vehicle maker BYD and artificial-intelligence upstart DeepSeek reshape the global market the way Japan Inc. did in the 1980s.