Japanese Stocks Rise While Yen and Government Bonds Waver, Signs of a ‘Takaichi Trade’ Revival

Yen Weakness and Government Bond Selling Pressure Expand Simultaneously
Markets on Alert Over Possible Unwinding of Yen Carry Trades
Exit Strategy or Market Stability, Interest Rate Decisions Grow Difficult

As the ruling coalition secured victory in Japan’s House of Representatives election, markets are once again turning their attention to the so-called “Takaichi trade.” Expectations that aggressive fiscal policy and a growth-oriented stance will continue have fueled a positive reaction in the equity market, while downward pressure has simultaneously emerged on the yen and Japanese government bonds. These political variables are amplifying caution across financial markets by stoking concerns over rising long-term interest rates, the potential unwinding of yen carry trades, and the increasing burden on the Bank of Japan’s monetary policy decisions.

Markets on Guard as Signs of Rising Long-Term Bond Yields Emerge

According to Nikkei, the landslide victory of the Liberal Democratic Party led by Prime Minister Sanae Takaichi and its coalition partner Nippon Ishin no Kai in the House of Representatives election held the previous day has fueled expectations that the “Takaichi trade,” characterized by a weaker yen and falling Japanese government bond prices, could return in earnest. Quoting KCM Trade analyst Tim Waterer, Nikkei noted that “the policy agenda aimed at stimulating the economy under Prime Minister Takaichi is likely to be positive for equities,” while adding that “as fiscal stimulus measures promoted by the LDP are increasingly likely to be implemented, depreciation pressure on the yen in the foreign exchange market is expected to intensify further.”

Even before the election, movements reflecting expectations that the Takaichi policy line would be maintained had already been observed in Japan’s financial markets. As prospects for continuity in the governing framework and fiscal and monetary policies gained traction, buying interest flowed into Japanese equities, while downward pressure weighed on the yen and Japanese government bonds. The TOPIX closed at a record high on the 6th and has risen more than 8% year to date, far outpacing the roughly 2% gain in the MSCI World Index over the same period. By contrast, the yen–dollar exchange rate fell 1.6% over the past week alone, slipping into the low 157-yen-per-dollar range and once again approaching the 160-yen line that authorities have cited as a threshold for considering potential currency intervention.

In the government bond market, concerns over selling pressure also intensified in the wake of the election results. Shortly after news of the LDP’s decisive victory broke, several major asset managers, including Schroders and JPMorgan Asset Management, reduced their holdings of Japanese government bonds below benchmark levels, particularly in the super-long segment. In phases where the likelihood of fiscal expansion rises, institutional investors typically cut exposure in anticipation of increased bond price volatility. The prospect that fiscal expansion measures such as the LDP’s proposed time-limited reduction in food consumption tax could materialize has heightened concerns over greater bond issuance and renewed questions about Japan’s fiscal sustainability, underpinning these decisions.

Views on the future direction of government bond yields remain divided. Katsutoshi Inazumi, chief strategist at Sumitomo Mitsui Trust Asset Management, said that if consumption tax cuts are implemented, long-term yields could exceed 2.38%, the highest level since 1999 recorded in January earlier this year. In contrast, Nin Okumura, chief interest rate strategist at SMBC Nikko Securities, argued that “if fiscal policy is adjusted toward a more realistic path, yields could instead decline and the yield curve may flatten.” This suggests that the trajectory of the Takaichi trade will hinge on how far the LDP’s fiscal policy proposals are concretely developed going forward.

Unwinding of Yen Carry Trades Puts Global Markets in Focus

As Japanese long-term government bond yields show signs of trending higher, concerns are growing that the structure of yen carry trades could come under strain. Yen carry trades, which involve borrowing low-interest-rate yen to invest in higher-yielding overseas assets, become less profitable as Japanese interest rates rise. If Prime Minister Takaichi further consolidates her political base and fiscal expansion continues, leading to a gradual increase in long-term yields, funds maintaining yen carry positions may increasingly shift toward unwinding. Market experts are therefore closely watching the direction of capital flows that could emerge as changes in the interest rate environment accumulate.

The renewed focus on yen carry trades reflects market conditions shaped by a combination of yen weakness and a low-volatility environment. In the foreign exchange market, the yen’s depreciation trend—at times hovering around the 155-yen-per-dollar level—has been widely cited as a factor driving the expansion of yen carry trades. One-month implied volatility for the yen–dollar pair briefly dipped into the 7% range in early November last year before quickly rising to the low 8% range, a level similar to the period in 2024 when the Japanese government intervened by purchasing yen. With considerable time remaining before the Bank of Japan’s next monetary policy meeting, this trend is expected to persist for the time being.

There are, however, complicating factors. At the end of last year, a U.S. government shutdown delayed the release of International Monetary Market (IMM) currency futures position data compiled by the Commodity Futures Trading Commission (CFTC), making it difficult to accurately assess the scale of speculative yen carry positions. Reuters observed that “the absence of data has left many investors without clear direction,” adding that “once IMM position reporting resumes, a judgment that yen short positions are excessive could trigger a full-scale unwinding.” Just before the U.S. government shutdown, yen long positions were estimated at around 79,500 contracts.

Constraints on the Bank of Japan’s Monetary Policy Flexibility

The Bank of Japan’s monetary policy calculus is becoming increasingly complex. Last year, the BOJ raised its policy rate from around 0.5% to approximately 0.75%, taking another step away from the ultra-loose monetary easing stance it had maintained for decades. This marked the highest policy rate level in roughly 30 years since 1995. However, subsequent monetary policy meetings resulted in consecutive decisions to hold rates steady, reflecting a cautious approach toward the timing and pace of further hikes. While the direction of policy normalization has thus been confirmed on the surface, analysts note that the BOJ has entered a phase where it must carefully weigh the market impact of any additional rate increases.

In practice, the market environment confronting the BOJ is highly complex. Within Japan, the prevailing perception remains that real interest rates are still negative, a view the BOJ itself has acknowledged by stating that “real interest rates are expected to remain negative for a considerable period.” At the same time, inflation nearing the 2% target and continued wage growth provide justification for gradual rate hikes. The BOJ has previously stated that “if a virtuous cycle from wage increases to price pass-through and further wage gains is maintained, the degree of monetary accommodation will be adjusted.”

However, the ripple effects of rate hikes constrain the BOJ’s room for maneuver. Raising policy rates can put upward pressure on long-term yields, directly affecting the yen’s value and capital flows. With 10-year Japanese government bond yields already exceeding the 2% level, the BOJ faces a difficult balancing act, unable to indefinitely postpone normalization yet also unable to accelerate it easily. In particular, if rate hikes were to trigger a sharp appreciation of the yen or abrupt shifts in global capital flows, they could conflict with the central bank’s core mandate of maintaining financial market stability.

The political environment further complicates the BOJ’s decision-making. Prime Minister Takaichi’s emphasis on “responsible yet proactive fiscal policy” has fueled expectations of fiscal expansion and contributed to downward pressure on the yen. At the same time, she has expressed strong caution over further depreciation of the currency. While curbing yen weakness would require rate hikes, such moves could also intensify long-term yield increases and market volatility, creating tension between policy objectives. This is why financial markets in Japan and around the world are closely focused on the BOJ’s upcoming monetary policy meeting scheduled for mid-March.