Why Japan's Elections Could Blow Up Global Bond Markets | Weston Nakamura

24:19Demetri Kofinas:So they were coming into this election already having lost a lower house. Having lost a lower house majority, right. And in between this election or that election, this one, there's also a Tokyo election about two or three weeks ago. The LDP also got crushed and lost a lot of seats there too. So that's a second election that he's now like kind of messed up under his watch. Then comes this one. And this one is already like expected to be the LDP is going to lose their majority. And indeed, they did. And so they lost the majority. And you started seeing like a lot of different, not just like the major opposition parties, but a lot of the smaller, quote unquote, fringe parties getting a lot of share and all that.

24:58And we're obviously going to get into that with the kind of implications on the JGB markets and all that. But Prime Minister Ishiba, now he's like three for three, oh, for three rather, okay? Right. Anybody would be stepping down at this point. Right. And a lot of prime ministers previously have stepped down.

25:13Demetri Kofinas:Stepping down as leader of his party. As leader of his party. He doesn't have to necessarily. But Prime Minister Abe actually in his first term, he had a very short first stint as prime minister. He stepped down. And at that time, then a younger Ishibe was criticizing Abe saying, you need to be stepping down like upon these horrible election results and giving up the majority and blah, blah, blah. blah, blah. Same scenarios now facing him. He is remaining in power. So in power, as in like, he is clearly just a sitting lame duck and we don't know when he's going to be gone. It could be at any moment, but it's really not up to anybody else but himself for now.

25:52And also, because the ruling coalition has lost their majority in both the upper house and the lower house, and now you have this lame duck hated by everybody, including those in his own party, prime minister who is now presiding over these non-majority parties in both houses. Now there's a big question of these different coalitions. How are they going to coordinate and how are they going to compromise one another and pass legislation? And so this is when the real game begins. And these elections didn't really do anything other than confirm that, yeah, establishment out. But now is when the horse trading and all that begins and the uncertainty over the bond market overhangs.

26:32Okay.

26:32Demetri Kofinas:So before we get into the specific policy changes that the opposition parties have been proposing and the effects that they could have on the Japanese bond market and further on to other markets as well, let's just clarify a few things here because not everyone listening to this podcast understands how parliamentary systems work. Right now, these parties, including either the LDP party or the Kometo party, and now everyone's going to hear how horrible my Japanese accents are and how you pronounce these words, but these two parties, which combined to form a governing coalition, now one of these two parties or both will need to seek opposition party support in forming a new coalition government.

27:11Demetri Kofinas:And a number of these opposition parties have been advocating for policies that you deem to be very dangerous for the world's most dangerous bond market. What are the prospects of a coalition forming? Let's take this step by step. One, what are the prospects of a coalition forming? And is there a prospect of a coalition forming that would be amenable to some of the previous policies, including potentially trying to normalize the JGB market and the BOJ's balance sheet to the extent that that was a policy, and a policy that can even be enacted without further turbulence? Because as you suggested or stated in your series of answers, they're kind of stuck.

27:50Demetri Kofinas:The BOJ is kind of stuck within a rock and a hard place. But to what extent can a coalition party be formed that kind of continues business as usual? And to the extent that it can't, what does that mean? Do we go back into another series of elections? And what are the prospects coming out of that? Do you think we're going to get even more support for opposition parties? Break down the sequence of events here. Yeah. So the question to all those is just very honestly, I don't know, and nobody does. So the elections were on Sunday and we got the election results very early a.m., you know, Monday morning for Japan.

28:24But Monday was a Japanese holiday, so markets were closed. So today, Tuesday, was the first chance for cash JGB markets, cash equity markets to sort of respond. But we didn't really see that much reaction in dollar-yen in anything else. Why? Because nothing has been clarified right now. And because we're in the state of like, I don't know if to all of those answers.

28:45Demetri Kofinas:There was a bit of a move in dollar-yen after the elections or right before the elections, wasn't there, in anticipation of the results? But you're saying it's not particularly material. Well, no, no. So you're totally right about that. So leading up from July, if you look at a chart from July 3rd, which is when Upper House election campaigning began, look at a chart of dollar-yen, look at a chart of JGB yields, and therefore US Treasury yields at the long end that are being pulled up by JGB yields. You'll see that prior to that, in June and all that, those things were on a decline and And they suddenly had a sharp upwards sort of move.

29:16And JGB yields at the long end, 30-year and 40-year yields back up to all-time record highs. That is because the markets were pricing in that the establishment LDP party, Liberal Democratic Party, that they are going to lose their majority. And so the opposition, who as fractured as they may be, they all have one singular sort of commonality. And that is what the government response should be to this primary issue of the election, which is the cost of living, the high cost of living. What are you going to do about it? The LDP and Comedo Party, the establishment party, they took the approach of 20 ,000 yen per person or, you know, like$170 or so of cash handouts.

29:58The opposition is proposing various forms of consumption tax cuts. And those could be anywhere from just on food because it's 10 % consumptive tax on all items and then for food it's 8%. So just on food down to 5 % and then kept for just maybe one year or something like that. And then that would be about, I don't know, like 2 trillion yen in terms of cost to government. And at the other end of the spectrum is basically cut consumptive tax cuts down to zero and leave them there and do that immediately. and that would be a cost of about 20 trillion yen or more. And to put things in perspective, 20 trillion yen, that figure is about one-fourth of total tax revenue, 80 trillion yen for last fiscal year.

30:47So you're talking about a quarter of government income just gone in that sort of extreme if that particular party got their way, essentially. So the markets are trying to figure out who is going to align with who, how they're going to do it, you know, the horse trading, all that kind of thing. And so I don't know. I don't know, Dimitri, what the answer is. And that's what I'm trying to monitor and find out. And that's what we all are very much because that is going to matter if it's the, let's say the Sanseito party, this new party that just, you know, the MAGA of Japan, if you will, right?

31:19Demetri Kofinas:Are they closer to MAGA or are they closer to the AFD in Germany? So they directly talk about the fact that their slogan, Japanese first, is inspired by Mr. Donald Trump. So, I mean, you can take that as a... And they increased their seats from one to 15 in this election, correct? Yeah, yeah, they crushed it. They crushed it. So they're supposed to be like a fringe right or whatever. What they are is the LDP is basically, if you think about it, like the Republican Party, right? Establishment Republican Party. They are like the conservatives who got sick of non-conservative or like they just got sick of the establishment and they just broke off and they have their own sort of grassroots, very much grassroots sort of driven thing.

32:00They were attacked by media. The more they were attacked, they would get more popular, and now they have a serious presence.

32:04Demetri Kofinas:So let me just, if you don't mind me interrupting you, and I'm probably going to have to do this a few times, just to try and - Not at all. I just want to try and compartmentalize some of this stuff here just so we don't get lost. So we'll go back to the extent that we can, we'll get back into the conversation about Japanese far-right populism and politics. I also want to understand a little bit better, what are the core issues that animated the support for the opposition party. But real quick, something that I want to understand here is, do you think that the current dysfunction, let's forget whether or not a coalition government is formed, whether or not some of these policy proposals like a consumption tax cut are implemented, but just the political turbulence that we're currently existing in at this moment, given the election results, do you think that this is what was being priced in with those moves and yields and in the yen?

32:50Demetri Kofinas:And do you think that it's priced in at this point? How would you answer that question? The information that the public has basically had so far agreed upon and had come to fruition, which was that the LDP was going to lose its majority, that was priced in. So the 3 % or 4 % move higher in dollar yield in the weeks leading up to that, and the move to higher in long-end yields and all that, that was pointing to all roads point to a worsening fiscal situation in no matter what the outcome of the elections are. But did this price in fiscal gridlock? Because it doesn't seem that it's priced in stimulus yet, right?

33:24No, but what it is pricing in is that, I mean, you can say it's gridlock, but the cost of living... So Japan actually has the highest inflation rate amongst all the major economies, which is an insane thing to say currently. And so rightly people are pissed off and they voted on action to be taken.

33:40Demetri Kofinas:What is the inflation rate in Japan right now? Headline is 3.2, something like that. And how many years have we been around this level? We've been about, this is about like the third year now. This is like, what is it? Something like 30 something months above the 2 % Bank of Japan target consecutively, for which the Bank of Japan says that they have yet to reach that target. And the yields on Japanese 10-year bonds are what roughly? Like one and a half, 1.5%. But if you look at yield spread like a, you know, 10s, 30s on JGB yields, Those are just blasting massively higher. And that's how you need to look at a yield curve steepener in Japan.

34:22You have to look at the 10-year yield because that's the one that was artificially pinned down versus the 30 and 40 years and so on and so forth.

34:27Demetri Kofinas:So am I correct to infer that the primary campaign issue that has animated support for the opposition parties has been the cost of living in Japan? Correct. And so let's then get into what the specific policy proposals are. I mean, you mentioned there have been two. The current ruling party has proposed cutting checks and handing them to people. The opposition has proposed consumption tax cuts, and these have varied. I've seen this, there's a whole list actually in your blog post that shows kind of what different parties are proposing, how quickly to implement those tax cuts, how long to keep them on, whether they keep them on indefinitely or not.

34:58Demetri Kofinas:I guess my question is, if we were to see, let's say some of the more extreme scenarios, if some of these extreme policies were implemented, because a governing coalition came together that supported these policies, what would that mean? Can you put a number on that for JGB yields? And what kind of dislocations are we talking about first for the Japanese bond market? And then for global bond markets, not just because of the impact that what's going on in Japan has on demand for other sovereign bonds, but also as a kind of canary in the coal mine. Because I love that you set this up at the beginning, which is that we've been looking at what's been going on in Japan since even before the 2008 financial crisis.

35:40Demetri Kofinas:In some sense, it's been a leading indicator. And so do people look at, let's say, a potential dislocation of the Japanese bond market and say, yo, this is what's coming for the French government bond market. This is what's coming for the US treasury market. And so it accelerates the concerns that are already in place and it accelerates dislocations in our own bond market. That's actually a brilliant way to think about it. Because basically, if people do indeed adopt the framework of Japan is a look into the future, then they're going to price that future immediately, right? Should they acknowledge it?

36:13So no, I can't put a number on it because in terms of yield levels or anything like that on the most sort of extreme cases of when you were talking about issuing 20 trillion yen or when you're talking about getting one fourth of tax revenue cut,

36:26Demetri Kofinas:all I can say is that in that scenario - If you can't put a number on it, does it mean we're talking about capital controls? I mean, what are we talking about in terms of additional policy changes that are going to occur as a result of extremely expensive financing costs for the government. So I can't put a number on it, but I can tell you kind of the scenario of things that I would imagine of market behavior, despite not being able to say down to the exact basis point. Sure, let's do that then. Yeah. So some of the biggest winners that unseated the establishment coalition party, ruling party, were basically that kind of not fringe right, But like the MAGA Japan, if you will, the Sanseito Party, right, as well as the Democratic Party of people of chance, so the DPP, right?

37:08So those two are basically in the camp of pretty aggressive consumptive tax cuts, OK? So they would be in more so of that area of having to – oh, by the way, and the thing is the reason that consumptive tax cuts, the reason cutting those down to any amount, the reason that that's controversial is because those are the revenues that go to Social Security funding. So what you're talking about essentially is it's not a matter of tax cuts and all that kind of thing, like consumptive tax cuts, like lower grocery bills at the register. It's are you suffering right now? Do you need relief right now? And are we going to take care of that at the expense of the elderly growing population of elderly?

37:49And overwhelmingly, the vote was like, yes, that is what we want. And what about the state of Social Security? We're concerned. Sure, that's not a good thing. But enough with like taking care of just that segment of the population. We need help now. And it's very tough to tell if whether or not those voters are doing so like knowing about if not OK with increased JGB issuance, in other words, debt that they have to repay later, or if they are doing so saying cut like consumer tax cuts down to zero. And if that means that social security can't be properly funded for old people, well, then too bad for them because we are suffering now.

38:36The rest, they have been taken care of under the establishment system. OK, so in that scenario, I would think that, look, we had in May, on May 20th of this year, you had one 20 year JGB auction that went poorly. OK, that took yields on 30 and 40 year JGB yields through the three handle. It took up took them up 20 basis points in a day. And it also brought 30 year treasury yields well through the five percent level. And then after that, a few days, you know, three or 40s after that, the Ministry of Finance came out and said that they're going to potentially do a twist in duration. They're going to drop their long end issuance, therefore not add to more supply of long end down effective immediately.

39:21And that re-crushed long end JGB yields down another 25 basis points back to where it was prior to that poor auction, the 20-year JGB auction. And that also crushed 30-year U.S. Treasury yields back below the 5 % handle. So that was just from one auction, and that was just from one headline of jawboning. If you actually implement real numbers, real policy, this is how delicate that the state of this world's most dangerous market is as is. If you now want to start talking about, I'm not talking about even like getting a quarter of government revenues like, you know, just slashed out, but even just like the potential commingling of parties that might lean towards that.

40:01You might see, you know, a severe effect in bond markets because of that second risk of why the JGB market is so dangerous because of the illiquidity, because of all that. And you can see a sudden jolt that can just, you know, it would be the Japanese Liz Trust moment. But the Liz Trust moment, you know, like I've always said, it should not be called the Liz Trust moment. It should be called the UK LDI crisis. That was not sort of like more sort of a response to like a fundamental response to like the UK government state of like the financial fiscal picture. It was maybe triggered by that. But UK 30 and 40 year guilds going up, you know, 100 basis points within a few days.

40:39That is a matter of like mechanical, you know, forced deleveraging of leverage positions and illiquid cash UK guild markets and bond markets such that the Bank of England had to step in, conduct yield curve control, you know, temporarily and all that. That is what I'm talking about for happening in Japan. And that could happen for any moment of these headlines and any of these combinations of possibilities that can come out. I don't know what's priced in and what's not because everyone's so different.

41:05Demetri Kofinas:So we've had a number of listener questions come in, in addition to the ones that I already had. Some of those have been answered already or were similar to some of the questions that I had. I'm going to take one now, but then I want to also ask you about the trade negotiations because we have the August 1st deadline coming up and I want to understand how these negotiations are impacting and have been impacted by the elections. But George has a question about the likely spillover effects of increased yields in the Japanese bond market on the Japanese equity market. And I want to add to that as well, what the implications are for equity markets more broadly.

41:37Demetri Kofinas:How closely have you been following that story? Yeah, closely, because I keep an eye on just the major cross asset markets. So not really on a stock basis, but if you actually look at a chart of NASDAQ futures and Nikkei futures, okay, they have actually moved percent for percent off of the post-Liberation Day bottom, right? Whenever that was, April 9th or whatever, until like sort of recent. And so what's happening is that, yeah, you're actually getting a lot of foreign inflows into Japan equities, institutional inflows, because everybody is consensus, you know, bullish Japan equities. Sort of at the index level, all it is is just following whatever it is that the other DM markets are doing.

42:22And it's not necessarily like driving it per se, although it will come to that at some point. The equity markets have been basically just kind of moving in tandem with that, with the exception of this past few days where you're starting to get some of the election getting priced in of a higher yield environment and all that. But that said, we have had this massive spike in Japanese government bond yields, including front-end BOJ policy rate hikes, if you will, if you want to call it a hike cycle or whatever. and you've still seen a resilient equity market. It wasn't nothing like 2022 of what the Fed did and what bond yields in the US did and what SPX did in response of just plummeting in the face of rising bond yields.

43:05That's not really happening in Japan. Japan is so different because if things are going to normalize, if you will, like if the bank Japan is out of the game, if the bond market is going to behave more normal and all of that, then that actually, some people would find that to be bullish equities. It's funny because the consensus-like viewpoint is a simultaneous Bank of Japan normalizing, tightening policy and a simultaneous bullish Japan, right? So those two things don't usually happen hand in hand, but in this particular case, it is because of how value destroyed Japan has been and the sort of transformational corporate shareholder governance sort of environment that's already underway that is happening kind of outside of and regardless of who is running the show in Tokyo politics.

43:54Yeah.

43:55Demetri Kofinas:I feel like we're living in the age of the sacrifice of sacred cows and the breakdown of correlations that people thought were ironclad laws of physics. It might be one of them. So I want to ask you about the trade negotiations before we talk about implications and lessons for US policymakers, which is something that I think is really interesting. And then maybe we have a little bit of time. We could talk a little bit about implications for investors and the Japanese far-right movement. But just real quick, what is the interplay here between the trade negotiations and these elections? Sure. So I wrote a sub stack.

44:28Let's see what's called how Japan screwed up dealing with Trump. OK, so the reason I wrote this was because I actually had written and recorded a whole series of videos upon Trump's reelection. So in November of 2024 and the implications of that. And they're all like playing out right now as we speak. But basically what I was saying was that Japan is really under this Ishiba clown is so screwed with an incoming Trump administration for so many reasons. And it's not really because of the Trump administration. And that's actually the known part, right? Like we know what his policies are. Unorthodox as they may be, he's actually the relative, you know, known.

45:05The unknown is this guy, this Ishiba guy, who is this, as identified very correctly, this like power clinging, self-interested, forget the country sort of guy, right? So basically Trump hits everybody in the world, allies and enemies and blah, blah, blah, with tariffs on Liberation Day. And right after that, though, Japan was given number one priority status for which to negotiate from. And not just given that status and not just talked about and explicitly given that, but actually was realizing that, was treated that way. You had seven in-person meetings with Japan trade delegation at Scott Besson's office, at Jameson Greer's office, at Lutnick's office and all of them.

45:52Seven in-person meetings. Nothing had come from that. So look, people, if you want to blame Trump and this and that, fine. I get it. I'm not talking about that. I'm talking about everyone keeps looking at things that happen as like, what did Trump do or Trump say? There is another side to it as well.

46:08Demetri Kofinas:Well, Bessette was on CNBC recently where he said something. He alluded to the Japanese elections when he was asked about a trade deal. Clearly, the Treasury Department understands that it's been difficult for the Japanese to actually come to the table here because of the elections. Now, I guess the question is whether something changes as a result of these elections or if the political gridlock means that we still don't get a deal. That's the thing. Yeah. Because this entire time, Japan has not really been negotiating in on good faith because Prime Minister Ishiba is not thinking about tariffs and saving the auto industry or anything like that.

46:42His first thought is, how do I remain in power and how can I play this for my election prospects? So when you go to the table like that, you're going to have a stance of what they've been saying. We demand you drop auto tariffs down to nothing. And by the way, we're not going to move an inch on rice tariffs, right? These rice tariffs that and haunting. The rice tariff thing is the stupidest thing, is the most easy layup that I personally think that the US government, the reason that they had been talking about Japan being like this prior number one status, priority country, is because they had intentionally set up Japan to like a t-ball, like softball toss to knock like a deal, a big deal with a major economy out of the park so they could have that headline and Japan was going to be that.

47:25And it would be easy because they know that Japan is suffering from this severe rice shortage domestically. And so if they just import California rice as they currently are, and they're paying the tariff anyway, because it's still cheaper than domestic rice, and then they could work out some sort of deal on autos and all that. But Prime Minister Ishabib wants none of that. And he's trying to play hardball. I think he's looking at the carnies of the world in Australia, and he's seeing this formula of those who are incumbents that have their approval ratings in the dumpster, but who become tough on Trump, they then find themselves in victory.

48:01I think he tried to do that. But this entire time, Japan's not been acting in good faith, and they were given a silver platter that nobody else has. So it's on them. So now they're going to scramble around for that. But now that Ishiba is a powerless guy, the Trump administration, they're going to be like, dude, what are you talking about a deal in the next 10 days? We don't even know if you're going

48:21Demetri Kofinas:to be around in the next 10 days. So I have a question, Weston. Again, there are all sorts of ways in which this can spill over into US markets. We've talked about that a little bit. And of course, we were just talking about how this can impact the trade negotiations, which is important for the Trump administration, both materially and also politically. How do you think that policymakers like Fed officials, Jay Powell over at the Fed, or Bessett over the treasury are looking at this in terms of being a premonition or a canary in the coal mine for the kinds of problems that they're going to have to be dealing with domestically.

48:56Demetri Kofinas:And do you think that it accelerates the timeline? We've talked about the accelerated timeline potentially for investors, but does it accelerate the timeline for some policy changes or coordinated policy changes in Western capitals to get ahead of something like this happening in their countries? Are you talking about now potentially central bank monetary policy implications from - Monetary and fiscal policy implications. What are some of the lessons that, look, with the List Trust moment, I don't know to what degree they heeded the lessons, US policymakers heeded the lessons or policymakers and other European capitals, but certainly that was an early quake that officials could look at and say, this could happen to us.

49:37Demetri Kofinas:Maybe we shouldn't pass tax cuts if people are concerned about our ability to continue financing our deficit. And so I'm just curious, what do you think, maybe it's too hard to say what lessons they're drawing, but what lessons do you think they should draw from what's going on in Japan right now? I'm almost kind of proud of this, of the Japanese electorate, of what they did, because I'm not saying I'm an anti-establishment, like trash. I leave personal politics out of this. But what you saw was a rejection, a rejection finally from the Japanese people of handouts from government. And one of the major reasons that they lost.

50:13So like a lesson is, no, you cannot just bribe your way to 20 ,000 yen per voter for a vote. They are actually going to turn on you for that. A lot of that was happening. And so like it's a matter of like, are you listening to our like actual concerns or are you not? And are you just trying to like give temporary ad hoc sort of responses or not? And if you are, you, the establishment, whoever you are, you need to reinvent yourself because if you just keep going on with the way that it is, the voting public is going to shake things up for you, if not like the bond markets sort of themselves. Right.

50:51And, you know, as it relates to like, you know, central bank policy. Well, I mean, what I was saying about the Bank of Japan is like Bank of Japan rate hikes for this cycle. those are done right those are like basically those are done in kind of all scenarios right like basically if you have a 25 tariff on japan coming you know in a few days because the trump administration is not going to do anything with this government then you're going to have not just gdp get destroyed in japan and not just like uh corporate international multinational corporates no longer just keep increasing wages and pull real wages out of the you know from deeply negative of territory.

51:27But as that happens, OK, therefore, Bank of Japan rate hikes are done. If we're going to be stuck in some sort of potential tariff, you know, coming or not coming, you know, just kicking that like deadline down the road thing, then that's going to keep central bankers frozen or the Bank of Japan frozen in place because we're not going to make a move before we have any clarity. And so therefore, the longer that continues, that means that the rate hike cycle is done. You know, if you're going to be tariffed and you're going to see government officials go from literally fighting with the interventions, fighting downside on the yen to now almost embracing it to kind of balance out tariffs on imports, then you're going to see the Bank of Japan no longer hiking rates because they are not incentivized to support the yen, they're not incentivized to weaken it.

52:11And also, if these auto tariffs remain as is, then Japan Inc. is the king of doing what? Cutting consumer prices to make up for things, right? And so that's why you saw like a 20 % drop in prices for Japanese autos that were shipped to the US for the month of May to combat the increased tariffs. So if that keeps happening, then you have suppliers of those auto companies get asked by the Toyotas and the Hondas to also lower theirs prices. And then we fall back into this corporate deflationary thing. And the Bank of Japan is done hiking their interest rates and so on and so on and so forth. Like all of these sort of scenarios like kind of end up there.

52:50The only thing is if you get yen weakness without tariffs somehow to the point where it gets to like 160 plus, then you might have, you know, Bank of Japan policy enter the picture. But otherwise, I would say that the BOJ side of it is pretty much done with. I would think that anything that Powell does or doesn't do is going to be looked at through a political lens. Sucks for him. And so I think he's going to write out the rest of his tenure as appearing as apolitically as possible, as opposed to anything that is what is best for the economy.

53:20Demetri Kofinas:So we're up on the end of our time here. I want to encourage our members to check out your Substack across the spread, which they can find at westinnakamura.substack.com. And check out those last three articles because you go into so much detail there, Weston, and I found it to be extremely helpful. As I mentioned, there was a bunch of other stuff that I had written out here that I wanted to talk to you about and ask you questions about, in particular, the far-right politics in Japan, but that'll have to wait for another time. Thank you so much for coming on the Genius Community and talking with our members today, Weston.

53:50It's been an honor. Thank you so much, Dimitri.

53:53Demetri Kofinas:If you want to listen in on the rest of today's conversation, head over to hiddenforces.io slash subscribe and join our premium feed. If you want to join in on the conversation and become a member of the Hidden Forces genius community. You can also do that through our subscriber page. Today's episode was produced by me and edited by Stylianos Nicolaou. For more episodes, you can check out our website at hiddenforces.io. You can follow me on Twitter at Kofinas, and you can email me at info at hiddenforces.io. As always, thanks for listening. We'll see you next time.

54:34Thank you.