Japan decides, global markets move

0:00Patrick Coffey:Welcome back to the Barclays Brief. It's Patrick here. And each week we try and pick one big market theme to focus on. And honestly, today I was completely torn. On the one hand, we've had this huge sell off in the software sector. But we've also had the Japanese election, which kicked off on the 8th of Feb. Now that's shaping up to be a genuinely macro moving event. So when I woke up to headlines about a landslide win for the LDP party, and then looked at the market reaction, it settled it. I should say we're recording this on the 9th of February at 10.30am London time. So by the time you listen to this, quite a lot may have changed.

0:36Patrick Coffey:But it's brilliant to be joined by Yun Zhang, our head of macro trading for Asia Pacific. Yun, thanks a lot for joining. And how's today been for you?

0:45Yun Zhang:Thanks, Patrick, for having me. What an interesting day in Asia session. I'm very happy to talk about what happened in Japan today.

0:52Patrick Coffey:Great. Well, let's get into it and maybe start with the obvious one. Why should someone outside of Japan care about this Japanese election?

1:01Yun Zhang:I think there are three main points. One is Japan is the fourth largest economy in the world. Second is Japan is the origin of so-called carry trade, where you borrow in low-yielding currency and invest in high-yielding currency. If effects don't move or move less than forward implied, you will make money. In global markets, carry trade is the basic strategy traders go back time after time. The third point is government bond. In recent years, post-COVID, there are a lot of tension building up in long-end bond market, where investors have concerns on fiscal situation of many countries. When we see 30-year JGB reached 3.88 % on 20th of January, that is certainly the highest I have seen in my whole career.

1:50Yun Zhang:it brought nervousness across the globe. Higher government bond yields mean higher borrowing costs, which is not healthy for central banks' balance sheet.

1:58Patrick Coffey:And it has a ripple effect through the wider global market, of course. So Japan's a major source of global capital. As you say, it's a key funding currency. It's also got a huge consumer market. So with that in mind, can you walk us through the election results? What happened? How are markets reacting? Certainly.

2:16Yun Zhang:Takaichi's LDP party secured 316 seats in the lower house, which is a supermajority that we have not seen post-war in Japan. Let me remind you, the lower house has more power than the upper house. It can appoint prime minister, it can override upper house decisions, it can even pass the national budget by itself. Leading up to election on Friday, there were already a lot of media reports that Takeichi must secure a supermajority due to her very high personal approval rating. So the final result is not really a surprise to anyone. The so-called Takeichi trade is long equity, short JPY as a currency, and built steepener in JPY rates curve.

2:59Yun Zhang:Without going into too much details, the long equity part did materialize, but I'm afraid the effects and rates didn't really work today in Asia section.

3:09Patrick Coffey:Interesting. So the LDP landslide after the election wasn't a surprise, but what is a surprise is how the market's reacting today. And I want to touch on that in a moment. But it does set up questions about households and policies first. So let's get into that. What are the big promises that Takahichi made in terms of taxes and the cost of living? And what's realistically coming in your view?

3:28Yun Zhang:Before we talk about tax and cost of living, I want to briefly mention what happened to Japan inflation. Since 1990s, the asset bubble burst in Japan. There is a long period of low interest rate policy, bankrolls decades. Japanese households are not used to see rising of prices. So the social unrest is real after rapid inflation pickup. A consumption tax cut is a very efficient election tool, in my view, and which Takechi used. However, what is the reality. I did argue before in late 2024 that why I thought China's situation was not as bad as people thought. One of the main reasons was that high household savings versus GDP, but the number of household savings versus GDP is actually higher in Japan.

4:18Yun Zhang:Furthermore, most of the inflation is imported due to weak yen, which means there are other ways to lower cost of living. Of course, I'm not saying the new government will not follow through. If they do, given the legislation process and operational readiness, we are looking at five to six months before households can actually feel it.

4:40Patrick Coffey:Interesting. So clearly fiscal choices will feed directly into monetary policy. So let's just pivot and talk about the Bank of Japan, the BOJ. You mentioned a week of yen, and we know that the BOJ is watching that closely. What's the next move for the BOJ? Do they stay patient or does this push them to maybe act a little sooner?

4:59Yun Zhang:We talk a lot about Fed independence, but we rarely talk about BOJ independence. As the markets know, Japan Prime Minister can nominate BOJ governor and has large influence over BOJ. After her win in the lower house, she can easily delay BOJ hikes now. Will she do it though? I think that depends on her overall big picture. Fundamentally, through responsible fiscal expansion, she would like to improve productivity in an Asian society and bring higher earnings to improve wages to fight inflation. We live in reality and need to balance long-term goals versus short-term requirements. What could be an alternative of a hike?

5:41Yun Zhang:Maybe a continued bull market in equities. Japanese households have roughly 50 % of their assets in financial assets, including stocks. If the wealth factor continues, could that help dealing with the cost of living issue? That might not work in a country like the US, where wealth equality is bad. But in Japan, which has the lowest Gini coefficient in the top 20 largest economies in the world, I think it might have some chances. A delayed hike will buy some time for SMEs, who otherwise will be the biggest losers on the current policy.

6:18Patrick Coffey:So if policy stays gradual, FX will become the release valve. Let's talk about intervention risk. What are markets pricing here?

6:28Yun Zhang:I spend a lot of time talking to our investors and clients. 160, that is$1 to 160 yen, is a very important figure in many clients' mind. The intervention risk is real. While Takaichi may not be so keen to hike rates, she might be quite willing to intervene to release unrealized profit from BLJ's foreign reserve to fund potential food tax cuts This is an elegant solution to colouring issues. FT had an article talking about the Ministry of Finance as the biggest carry trader who has made more than 200 billion cumulative P &L in the past 30 years. It is more than enough to cover the$60 billion cost for full tax cut for two years.

7:20Patrick Coffey:Interesting. So lots to watch there as well. Bringing it back to real world impacts, who stands to win from this policy mix? We talked a lot about households, but what about other businesses? How are they positioned?

7:32Yun Zhang:Obviously, current weak yen will help exporters to fight against tariffs. While JPY as a currency will eventually strengthen due to higher growth rate, importers will benefit. I think service sector will benefit from here onwards, particularly banking sector. With higher yields or higher growth rates, banks' net interest margin will improve. Other areas which have a low productivity, such as retail, healthcare, business services, will benefit from AI investments.

8:05Patrick Coffey:Interesting. This is probably the first podcast where AI came up towards the end of the podcast. But looking ahead, what should we be watching over the next 90 days? What are the key milestones that markets have focused on from here on in?

8:18Yun Zhang:The immediate event will be around 18th of February, where a special diet session is expected. It will formally confirm the prime minister and begin parliamentary business, such as fiscal deliberations. Although a draft budget was approved by the cabinet at the end of 2025, the DAI will need to pass the detailed budget bill and tax measures before the start of fiscal year on 1 April. Cabinet posts need to be confirmed, although through all the current reports, Takaichi intends to keep the current cabinet as it is so she can get on with budget and other matters. The next BLJ meeting is scheduled to be 18th to 19th of March.

9:02Yun Zhang:We do not expect a rate hike. There is decent probability though priced in for the April meeting.

9:08Patrick Coffey:So lots of catalysts and lots to look forward to. Stepping back a bit, where do you see markets becoming most sensitive now? Is it currency, rates, bond market or risk sentiment more broadly?

9:19Yun Zhang:It's all about bond market. The bond market is still the basics I return to. It is not just for traders. It touches every aspect of a country. It is hard to ignore it. I think we have seen the peak of 30-year JGB yields. As my research colleagues Xin and Babasan points out, there is enough Takeichi premium built in in the JGB market. The confidence has returned to Japan market.

9:43Patrick Coffey:On that positive note, let's think about how Japan stacks up versus, say, China. I know you turned bullish on China before the rally last year. How do you think about Japan versus China right now?

9:55Yun Zhang:I do agree with the equity element of the Takahichi trade, but I do not agree the other two. As I mentioned earlier, yen will strengthen, hence higher growth rate. China is in that camp too, higher equity and stronger currency. So if you agree with these arguments, FX unhatched long equity play could work. Rates will be a lot more complicated. Big picture, I do feel back-end Japanese government bond has calmed down. The long-end flattener could work. Front-end will have more moving paths. Given how much hike is priced in, maybe a steepener makes more sense.

10:34Patrick Coffey:Great, Yun. Lots to think about there. Thanks a lot for joining me on the podcast today.

10:38Yun Zhang:Thanks, Patrick, for having me. What a long, exciting day.

10:41Patrick Coffey:So as markets digest this landslide victory, a few things stand out from our conversation with Yun. For Japan, the LDP victory brings a stronger mandate. Bond markets appear to have stabilized and confidence has returned to the Japanese market. Yet FX and rates didn't quite react as many expected today. Globally, however, the election matters a lot because Japan sits at the crossroads of FX rates and regional growth. The big swing factor now is the Bank of Japan. And if fiscal stimulus lifts inflation and forces a shift in policy, the yen will react and that will ripple through global markets.

11:18Patrick Coffey:So lots to watch for. Thanks for listening to The Barclays Brief. Do hit subscribe and we'll be back next week.