The ruling coalition suffers a defeat in the Senate elections, power struggles and budget uncertainties loom large! Will the "Japanese government bond storm" sweep through the market once again?

Due to traders' reaction to the ruling coalition's failure to win a majority in the latest round of Senate elections in Japan, the yen has continued to strengthen against the dollar. In the initial stages of trading, uncertainty in politics, economics, and finance often benefits the yen exchange rate due to safe-haven buying driven by uncertainty. However, the election results where the ruling coalition lost the majority in both houses of parliament is not good news for the entire Japanese assets. Especially as the majority parties outside the Liberal Democratic Party have proposed tax cuts that could lead to significant expansion of Japan's fiscal budget. Therefore, after news of the ruling coalition losing majority seats in the Senate, the long-term (10 years and above) Japanese government bond yields are likely to rise rapidly, potentially leading to another "Japanese government bond storm" that could once again impact global financial markets. At the beginning of the Asian market session on Monday, the dollar dropped by 0.7% against the Japanese currency, reaching 147.79 points, while Japanese stock index futures remained relatively stable. On Sunday evening, Japan's public broadcaster NHK reported that the ruling coalition between the Liberal Democratic Party and its long-term ally Komeito had lost their majority seats in the latest Senate elections. This is the first time since 1955 that this historically prominent Japanese political party has been unable to govern the country with a majority in both houses of the parliament. According to the latest reports from NHK, in this Japanese Senate election, the opposition and non-partisan forces have already obtained 76 seats, plus 48 non-renewed seats, totaling up to half of the Senate (124 seats). In other words, the ruling coalition composed of the Liberal Democratic Party and Komeito has failed to reach a majority in the Senate. Political analysts have pointed out that there is a possibility of a change in leadership in Japan, mainly because the ruling coalition has lost its majority in both houses of the parliament, which would force the government to compromise with the opposition on every bill submitted to the parliament. If Shinzo Abe resigns under pressure from the opposition, there is a possibility of the scenario of the Liberal Democratic Party electing a new leader unfolding once again. The Japanese market is about to witness a "triple shock" However, with reports indicating that the current Prime Minister Shinzo Abe, who belongs to the Liberal Democratic Party, is attempting to continue governing with the support of some opposition parties, Japan is heading towards a period of high political and economic uncertainty. "Uncertainty usually favors the yen at least in the initial stages," said Rodrigo Catril, a foreign exchange strategist at the National Australian Bank in Sydney, in an interview. "Overall, the election results are not favorable for the entire Japanese assets in the long term, and we will consider selling the yen on uptrends due to its strength." Japanese media have pointed out that the Liberal Democratic Party led by Shinzo Abe may choose to incorporate an opposition party into the ruling coalition to maintain a majority in the Senate through a "triple-party ruling coalition" format. However, the risk is that the opposition parties in Japan may form an alliance to take over the government from the Liberal Democratic Party and Komeito coalition. In the weeks leading up to the election, traders have been on edge, fearing that poor performance by Abe's party could open the door to larger government expenditures and tax cuts. This concern undoubtedly put significant pressure on the yen exchange rate, pushing Japanese long-term government bond yields to their highest levels in years. Since President Donald Trump announced his radical tariff measures in April, the volatility of the yen has been continuously rising. The Senate elections have not brought any relief in terms of trade uncertainty, as Japan still faces the deadline of August 1st when the US government will impose high tariffs of up to 25% on Japan. Negotiations on a trade agreement between the Japanese government and the U.S. have made little progress. As Monday was a public holiday in Japan, the Japanese stock and bond markets were closed, making the yen the most important asset to measure investors' reactions to the ruling coalition's defeat in the Senate elections. With NHK's latest reports and comprehensive polls indicating a significant defeat for the Liberal Democratic Party coalition, investors have been preparing for potential "triple severe volatility" in Japanese government bonds, stocks, and the yen in recent days. Could the Japanese government bond yield trigger another severe global financial market shock? The upward trend in some long-term sovereign bond yields reflects investors' growing concerns about the continuous expansion of budget deficits. The yield of Japan's 30-year government bonds recently surpassed the crucial 3% mark, nearing the highs that triggered a global bond market crash in May; and the yield of Japan's even longer-term 20-year government bonds is at its highest level in nearly 25 years. As survey results on the Senate elections suggest that the ruling coalition may suffer a major defeat, heightening market concerns about a significant fiscal expansion in Japan. Investors are increasingly worried that a sharp rise in the yield of long-term Japanese government bonds, driven by the uncertain fiscal policies of the Japanese government, could lead to a new wave of the "Japanese government bond storm." With the U.S. non-farm employment data and other macroeconomic indicators showing resilience, and the effects of tariffs beginning to reflect in inflation data, market expectations for a Federal Reserve interest rate cut have significantly decreased - from expecting a 75 basis point cut to expecting less than 50 basis points. Along with Trump's "big and beautiful" bill being passed, the expectation of a significant expansion of government spending, exacerbated by the uncertainty surrounding the U.S. tariff policy, has put pressure on Japan's long-term government bond yields, leading to a sell-off in the bond market. Investors are particularly concerned about the rising demand for Japanese government bonds as fears of a continuing increase in budget deficits mount. As the current ruling party, the Liberal Democratic Party and its coalition partners, pursue a strategy of cash handouts to attract voters, while the opposition collectively advocates tax cuts. The party led by Shinzo Abe has promised to distribute approximately 20,000 yen (about $138) in cash per adult, and introduce more measures to stimulate wage growth. However, recent polls show that this one-time subsidy is not well-received, as many voters tend to support the opposition's proposal to reduce consumption tax. After President Donald Trump announced the increase in tariffs on Japan to 25% starting August 1st, the Japanese government is eager to reach a more favorable U.S.-Japan trade agreement. The uncertainty surrounding the tariff policy could exacerbate the risk of Japan slipping into a technical recession, and the market is beginning to worry that if the Japanese government succumbs to pressure from the U.S. and signs a trade agreement that is unfavorable to itself, the fiscal expansion in Japan will become more aggressive - mainly to alleviate the domestic economic pressure brought by the tariff policy. In Japan, the core buyers of government bonds - the large life insurance companies, remain cautious. Meiji Yasuda Life Insurance has stated that they plan to avoid actively investing in ultra-long-term Japanese government bonds over the next one to two years, as the Bank of Japan may continue to raise interest rates and the fiscal expansion may become a reality. The government bond yield may continue to rise, with increased supply pressure, at a time when the Bank of Japan, as the largest holder of Japanese government bonds and the dominant force in the market for many years, is trying to gradually exit the government bond trading market. Since the beginning of this year, global long-term government bond yields have continued to soar, with some of the world's largest central banks issuing new warnings about fiscal spending, growing debt, and the demand for long-term bonds. Therefore, under the push of "term premium", the yield of the 30-year U.S. government bond has recently climbed back to the significant 5% mark. The indication of term premium refers to the additional yield compensation demanded by investors for the risks associated with holding long-term bonds. In the eyes of some economists, in the era of Trump 2.0, government debt and budget deficits are expected to be much higher than official forecasts. This is mainly due to the new government led by Trump focusing on economic growth and protectionism with a core strategy of "substantial tax cuts domestically and imposing tariffs externally", combined with increasingly large budget deficits, U.S. debt interest, and military defense expenditures, the U.S. Treasury may be forced to expand borrowing at a much higher pace than the Biden administration, and under the backdrop of "de-globalization", China and Japan may significantly reduce their holdings of U.S. bonds, coupled with the risk of rising Japanese government bond yields spilling over, the term premium is expected to rise significantly as usual, and the yield of the 10-year U.S. government bond, known as "the anchor of global asset pricing" may be set to experience a more wild surge than in 2023, breaking through 5%. Overall, the tumultuous situation in Japanese politics and the uncertainty in global economic relationships have put significant pressure on the financial markets worldwide. As the situation unfolds, it will be crucial for investors to carefully monitor developments and adjust their strategies accordingly.