Japanese Election Update

Japan’s election is three weeks away. 
Since last June’s UK referendum, through the US election, and more recently,
the German election, there have been plenty of political surprises.  

Like Merkel, Abe may find that winning is not
enough.
  Merkel was denied a majority
and may have to form a coalition that no doubt will be more unwieldy than the coalition with the
SPD.  

There is little doubt that the LDP will remain
the largest party in Japan.
  The new national opposition party (Party
of Hope) is not fielding enough candidates to secure a majority in the new
465-seat Diet.  Moreover, according to a Kyodo survey, the LDP is drawing
support from about 24% of the voters, while the Party of Hope is pulling about
15%.  The survey found 43% were undecided.  

Abe can still lose by winning.  This sounds like an oxymoron, but there is
truth in the assessment.  The LDP has a simple majority (294 seats) and
a supermajority (329 seats) with the support of the Komeito Party.   If
the LDP loses its simple majority or 61 seats, Abe’s political future may be at
risk.  His term as LDP head ends in a year and he would likely face a challenger.   

Two LDP candidates come to mind.  The
first is Shigeru Ishiba, who heads a faction of 19 members in the lower
chamber.  The challenge is a faction needs 20 members to nominate a party
head.  The second is the new LDP policy chief and former Foreign Minister,
Fumio Kishida, who was given the new assignment as an apparent
concession after the stunning LDP defeat in the Tokyo elections in July. 

Abe is supporting several unpopular measures,
and the Governor of Tokyo and head of the Party of hope, Koike is pushing for
the advantage. 
Specifically, Abe supports re-opening nuclear power
plants and is committed to raising the sales tax from the current 8% to 10% in
2019. As part of his campaign, Abe has offered not to use the proceeds of the
sales tax increase to pay down the debt, as was the initial intention, but to
pay for pre-school and higher education.  Koike is campaigning to phase
out nuclear power and to freeze the sales tax.

The previous main opposition party, the DPJ
has largely folded into the Party of Hope.
  Some of its members may
run as independent candidates.  A left-of-center faction has formed a new party.  Koike may seek
cooperation from other small opposition parties.  For example, the
regional conservative Nippon Ishin no Kai has agreed not to run candidates
against the Party of Hope in Osaka.  

Abe also wants
to change the Constitution to strengthen Japan’s military presence.
 
More than half of the people Kyodo surveyed are opposed to the
constitutional changes Abe has endorsed.   About a third to those surveyed agreed with
Abe.   The Kyodo survey found that Abe’s approval rating fell below
his disapproval rating.  

Abe is a known quantity for investors. 
He offers fiscal and monetary stimulus.  He favors a soft yen.  This is the traditional LDP policy mix.  The policy of
the Party of Hope is not known.   Meanwhile, the Japanese economy is doing
nearly as well as Abe could have wished.  The Tankan Survey released
earlier today show sentiment among large manufacturers is at its best level
since 2007.  It is enjoying its longest expansion in several
years.  

Assuming the LDP remains the largest party in
Japan, but Abe is weakened, there would
still be increased uncertainty about the trajectory of monetary policy. 
BOJ
Kuroda’s term expires in early April next year.  Typically, the BOJ
Governor serves one five-year term.  While a weakened Abe may not be
strong enough to resist tradition, it is
likely that Kuroda’s replacement shares
his basic philosophy as opposed to return
to the Shirakawa era.  

We see two main drivers of the dollar-yen
rate. 
First and most important is the direction of the US 10-year
yield.  The correlation between the (percent) change in the US yield and
the (percent) change in the dollar-yen exchange rate over the past 60 days
appears to be the highest (0.82) since at least 2000.  Second, we pressure
on the yen coming from the large dollar premium for yen on a three-month cross
currency swap basis.  The dollar premium stands at 49 bp more than LIBOR
today, which is the most in seven months.  Recall that at the end of last
year, as the dollar traded above JPY118, the dollar premium on the three-month
cross currency swap was near 90 bp on top of LIBOR.  

In the options market, implied vol is jumped around the election (three-week vol
is ~9.95%, while the two-week vol is ~8.33%). 
With US 10-year yields
at the upper end of their six-month range, it should
not surprise
the dollar is firm
against the yen.  A preliminary shelf was
carved
in the second part of last week near JPY112.20.  Last weeks high was near JPY113.25.  The dollar
has run up for near JPY107.30 on September 8,
and the technical indicators are stretched
The Slow Stochastic has already turned lower.  However, the key takeaway
here is that the technical indicators of
the weekly bar charts suggest a
constructive medium-term outlook.  

Disclaimer

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