Rui Hoi expects the "post-election era" in Japan: Short-term focus on "Kashi trading", Mid-term attention on consumption tax reduction.

The Liberal Democratic Party (LDP) of Japan won 316 out of 465 seats in the House of Representatives election held on February 8. Mizuho Securities recently released a research report on the Japanese election, predicting the short- to medium-term market dynamics following the event. This achievement set a new post-war record for a single party in Japan and gave the LDP a majority in the House of Representatives with more than two-thirds of the seats, allowing them to resubmit bills rejected by the House to be voted on again. Including the ruling coalition with the Japan Innovation Party, they now have a total of 352 seats in the House of Representatives. Meanwhile, the main opposition force, the Constitutional Democratic Party, only won 49 seats, while the former Constitutional Democratic Party suffered a historic defeat, with many of its candidates losing in single-member constituencies. The number of House of Representatives seats for the Democratic Party for the People (DPFP) increased slightly, while the seats for the Party of Hope and the Future Party saw significant growth. Regarding the LDP's promise of a two-year tax exemption on food and beverage consumption tax, Prime Minister Sanae Takaichi of Japan stated that she believes this move is "just and reasonable" and will not issue special deficit bonds to implement this policy. After review by the newly established National Committee, she will promptly submit relevant legislative proposals to the Parliament. Furthermore, Sanae Takaichi listed the tax refund offset system as a "top priority." She explained that this is aimed at addressing the regressive nature of social security premiums, and the consumption tax reduction is a relief measure before all preparations are completed. Even if efforts are made to expedite the system design process, the related preparatory work may still take "2 to 3 years." Sanae Takaichi also praised the current Cabinet as a "highly responsible and successful team" and stated that she is not considering reshuffling the Cabinet at the moment. However, she expressed willingness to add a cabinet position specifically for the minor party, the Japan Innovation Party, within the ruling coalition. With almost unanimous calls from the opposition to reduce the consumption tax, the LDP has reduced the controversial nature of this issue by proposing a limited period tax exemption on food consumption tax. Sanae Takaichi remained silent on this issue as the election approached, avoiding market fluctuations and criticism from the opposition. The overwhelming victory of the LDP in this election was largely attributed to Sanae Takaichi's high popularity, who personalized the election by staking her own political career on it. Potential responses in the short to medium term: Indeed, with limited information currently available, market forecasts are difficult, but the bank has outlined its views on the short- and medium-term market trends. Short-term trends: Despite some opinion polls signaling the historic victory of the ruling coalition, the election itself still poses inherent uncertainties, which the market may not have fully digested. Therefore, in the initial stages, the market will likely be dominated by the so-called "Takaichi trade": the market expects Sanae Takaichi to consolidate her internal party support base and consequently implement her concept of "responsible and proactive public finance" more smoothly. In this context, the stock market may rise, the yield curve of Japanese government bonds may steepen, and the yen may face depreciation pressure. However, the response in the bond market may be more complex. Most market participants (even those in the dominant position) believe that the comprehensive victory of the ruling coalition may ultimately reduce the possibility of Japan implementing aggressive fiscal expansion policies. The fiscal policy stance of the Takaichi government will ultimately depend on market reactions and the results of the upcoming national committee discussions. The progress of consumption tax reduction and other expansionary fiscal measures will equally depend on this. In the bank's view, this ongoing uncertainty will make the bond market highly sensitive to Sanae Takaichi's future public statements, and there is a significant potential for interest rates to fluctuate significantly as a result. As Sanae Takaichi mentioned the benefits of yen depreciation in a campaign speech, the yen weakened last week. The bank also noted that the Bank of Japan may be forced into a "defensive mode" and accelerate the pace of monetary policy normalization. Specifically, under existing conditions, the Bank of Japan had originally planned to raise interest rates again in June or July, following its "routine" rhythm of raising rates every six months until April 2025 when the Trump administration announced "Liberty Day." However, the bank now believes that, depending on the yen's future movement in the coming weeks, the rate hike schedule may be brought forward to April, or even March. Medium-term trends: Once the financial markets have fully digested the election results, the focus will significantly shift to the feasibility of the consumption tax reduction policy, its potential scope, scale, and timelines. The ultimate direction of this policy will largely depend on whether the Takaichi government's fiscal policy deviates from fiscal discipline. At least in the bank's view, the fiscal discipline of the government was clearly evident in the budget for the 2026 fiscal year passed at the end of last year. Sanae Takaichi has stated that the consumption tax reduction policy will be implemented in the 2026 fiscal year and will not rely on issuing special deficit bonds for financing. As of now, there is no clear plan to fill the revenue gap caused by this policy (estimated at around 5 trillion yen per year). Takaichi has also mentioned that the details of this policy (including the differences between "exempt" and "zero-rate" taxes) will need to be discussed and finalized by the bipartisan national committee to be established soon. The bank anticipates that these discussions will take a considerable amount of time to reach a conclusion, given the significant controversy around funding sources and the divergence of opinions on policy design, even within the LDP. Specifically, the bank believes that the Takaichi government will need to first formulate the basic principles of economic and fiscal management and reform, solicit budget requests for the 2027 fiscal year, and only then start drafting the 2027 fiscal year tax reform plan by the end of 2026, at which point the specific details of the consumption tax reduction policy (regardless of their final form) may gradually become clearer. In summary, implementing the food consumption tax reduction policy before the end of the 2026 fiscal year (whether partial or full), is highly challenging. Due to the difficulty in reaching a quick conclusion on the related disputes, the bank expects market participants to continue monitoring the potential shift in fiscal policy towards expansionary measures, leading to a modest upward pressure on long-term and ultra-long-term Japanese government bond yieldsbecause the market cannot fully price or rule out any potential scenarios. So, how will the market react once the Japanese government finalizes the food consumption tax policy? 1. If a stable source of funding is found to fill the revenue gap: The bank believes that the likelihood of the government finding a solution to fill the approximately 5 trillion yen revenue gap is relatively low. However, if achieved, even if the low-tax rate status of the consumption tax continues for more than two years, concerns about Japan's fiscal discipline in the bond and foreign exchange markets will be alleviated to some extent. 2. If a stable source of funding cannot be found: A. One possibility is that the government adheres to its promise of not issuing special deficit bonds and chooses to postpone or only implement limited reductions in the consumption tax policy supported by existing funds. This will have no substantive impact on Japan's fiscal situation, and the alleviation of fiscal concerns will support the yen and long-term Japanese government bonds. However, the support rate for the Takaichi government is likely to decline as a result. B. Another possibility is that the government ultimately decides to implement a large-scale consumption tax reduction without financial support. This move will be seen as fiscal irresponsibility and may even trigger a "triple sell-off"the Japanese version of a "Taper Tantrum." In that case, the increase in long-term and ultra-long-term Japanese government bond yields will exceed the levels seen on January 20, and the domestic stock market and the yen will both face strong selling pressure. Currently, the bank considers scenario A more likely than scenario B. This is because Sanae Takaichi seems to be considering the potential market reactions, voters may not fully endorse the humanitarian effects of the consumption tax reduction policy, and the Trump administration is exerting indirect pressure behind the scenes.