Yen Caught Between Politics and Central Bank Policy

Its core is the expectation that the new government will restart a combination of large-scale fiscal stimulus and ultra-loose monetary policy, which is seen as a continuation of former PM Shinzo Abe’s “Abenomics.”

“Takaichi Trades” – Assessing the New Political Premium

She has clearly expressed opposition to interest rate hikes, a stance that fundamentally puts pressure on the Japanese Yen.

The market’s initial reaction was direct and intense. The Yen immediately weakened, USD/JPY quickly climbed from below, while the Japanese stock market (Nikkei) rose, and Japanese government bonds (JGBs) faced selling pressure. This price action reflects the market’s immediate expectations for the new policy mix: fiscal expansion will increase government spending, and pressure on the central bank may delay or prevent interest rate hikes, thereby maintaining or even widening the interest rate differential between Japan and major economies like the United States, weakening the appeal of the Yen.

However, the rapid depreciation of the Yen has caused official unease. Japanese Finance Minister Katsunobu Kato recently stated that the government is “closely monitoring the Yen’s recent rapid weakening” and expressed concern about “unilateral and sudden” exchange rate fluctuations. This is typical “verbal intervention” rhetoric, aiming to warn market speculators that the government has a tolerance limit for excessive exchange rate volatility.

A deeper analysis reveals the potential fragility of the “Takaichi trade” itself. The ruling Liberal Democratic Party (LDP) led by Takaichi has formed a coalition government with Ishin. The reality of this political alliance means that any major policy requires negotiation and compromise. Analysts point out that Ishin’s inclusion may act as a check on Takaichi’s most aggressive reflationary policies, prompting the government to adopt a more balanced economic approach.

Therefore, the market’s initial interpretation of the “Takaichi trade” may be overly simplistic. The inherent constraints of a coalition government mean that the final fiscal stimulus package may be smaller than market expectations or come with more considerations for fiscal discipline. This potential gap between expectations and reality sets the stage for a reversal of the “Takaichi trade.” Once subsequent policy falls short of expectations, the current USD/JPY exchange rate, inflated by political premiums, may face the risk of a rapid pullback.

Furthermore, this also exposes potential internal divisions within the Japanese government on exchange rate issues. The PM office may prefer a weaker Yen to boost export corporate profits and overall economic growth, which can garner business support politically. However, the Ministry of Finance(MoF) is more concerned with exchange rate stability and import costs.

A weaker Yen pushes up the prices of imported energy and food, exacerbating inflationary pressures, which is highly unpopular with the general public, especially with current inflation already above the central bank’s target. The Ministry of Finance’s verbal intervention is a manifestation of this internal tension, setting a “soft top” for USD/JPY‘s upside, backed by the threat of actual foreign exchange intervention.

Internal Divisions Within the Bank of Japan

Amidst changes in the political landscape, policy debates within the Bank of Japan are also becoming more public. Divisions among members regarding the future path of monetary policy are increasingly apparent. At the core of this debate is how to interpret current inflation data and when is the appropriate time for policy normalization.

A key figure in the hawkish camp is council member Hajime Takata. On 20 October, he once again publicly called for an interest rate hike, arguing that “now is an excellent opportunity to raise policy rates,” and emphasized that Japan is nearing its price stability target. This clear hawkish stance directly challenges the new government’s dovish tendencies and reflects the concerns of some policymakers within the central bank about sustained inflation.

In contrast, the cautious faction, led by Governor Kazuo Ueda, advocates for a more prudent approach. Governor Ueda has repeatedly emphasized that any interest rate hike in October will depend entirely on future economic data and whether his confidence in achieving inflation and growth forecasts strengthens.

Deputy Governor Seiichi Shimizu expressed similar views, pointing out that given Japan’s long history of low or even zero interest rates, there is great “uncertainty” about the potential reactions to interest rate normalization. Therefore, the central bank must “be very careful” in evaluating the consequences of policy actions.

The internal debate within the Bank of Japan is actually taking place in a more incomplete information environment. This makes the position of the cautious faction (such as Governor Kazuo Ueda), who advocate for “continuing to observe data,” more persuasive. They are fully justified in pointing out that any policy adjustment made before the release of key inflation data would be premature.

From a technical analysis perspective, USDJPY has broken through the downtrend line and formed a higher high structure. The price is above both moving averages, indicating that momentum has shifted to bullish. If it breaks above 152.50, the price may move up to test the next resistance level at 153.20. Conversely, if it closes below 152.50, the pair may fall back to the support level at 150.90.

Based on the above analysis, the market expects Japan to restart an active fiscal stimulus plan, which may delay the Bank of Japan’s monetary policy normalization and widen the policy divergence with the Federal Reserve.

Expectations of fiscal expansion may further increase downward pressure on the Japanese Yen.

US Side: Economic Resilience and the Data-Deficient Fed

Initial jobless claims have continued to be lower than market expectations in recent weeks. For example, in the third week of September, initial jobless claims were 218,000, significantly lower than the market consensus of 235,000, reaching a two-month low. This series of data indicates that despite economic challenges, corporate layoff rates remain low, which allays market concerns about a sharp deterioration in the labor market.

Secondly, recent remarks by Federal Reserve Chairman Powell have also reinforced market expectations. He emphasized that a strong economy and labor market give the Federal Reserve the “ability to proceed cautiously” when deciding the future path of interest rates. This means that until clear and sustained signs of economic weakening emerge, the Federal Reserve is not in a hurry to begin an interest rate cut cycle.

Ironically, the current US government shutdown has actually become a short-term positive factor for the US dollar. Due to the shutdown, important economic indicators, including the September jobs report and key inflation data, have been postponed. Chairman Powell has publicly acknowledged that if the shutdown continues, the Federal Reserve will “start missing data,” which will make policy decisions “more challenging.”

This creates a “shutdown paradox”: the market expects to see weak economic data to prompt the Federal Reserve to cut interest rates sooner, thereby narrowing the US-Japan interest rate differential and weakening the dollar. However, the government shutdown precisely prevents the release of these most critical data. In a state of “flying blind without data,” no prudent central bank would easily adopt an easing policy. Therefore, the Federal Reserve’s most likely option is to remain patient and wait for data to resume. This “forced inertia” in policy maintains the huge interest rate gap between the US and Japan, providing solid macro fundamental support for the USD/JPY exchange rate and acting as a resistance to any rebound in the yen.

The Bank of Japan’s monetary policy meeting, scheduled for October 29-30, will undoubtedly be the most critical event determining the short-term direction. The market is currently in a fragile balance, and every signal conveyed by Governor Kazuo Ueda at the post-meeting press conference – whether it’s his assessment of the inflation outlook, his views on the new government’s fiscal policy, or his responses to internal policy disagreements – could become a catalyst to break this balance.