Yen’s plunge a rational response to Japan’s election drama

TOKYO – Japan’s Sanae Takaichi is trying to drum up a better political environment to implement her vision for Asia’s No 2 economy.

Takaichi is doing so both literally and figuratively. This week, Japan’s first female prime minister went viral for demonstrating her drumming skills, which she honed in college. The sight of her playing next to South Korean President Lee Jae Myung in Tokyo was PR gold for Takaichi’s Liberal Democratic Party. It’s all part of her effort to mend fences with key export markets and a major tourism suppliers.

Yet the charm offensive is aimed at Japanese voters as Takaichi jams a bit politically, too. She just announced that the LDP is taking a risky but potentially rewarding gamble on a snap election.

The hope is to harness an approval rating as high as 60% to win back a direct majority in the lower house of parliament. This might afford her greater scope to joust with China and raise Japan’s competitive game.

Yet the yen’s decline immediately after Takaichi announced her election plan for February suggests global markets aren’t optimistic about their chances of revamping the US$4.2 trillion economy.

Torsten Slok, chief economist at Apollo Global Management, notes that yen trading activity is “indicating that growing concerns about Japan’s fiscal position in a rising rate environment are starting to dominate.”

Here, markets may have a point—both in the short run and the long term.

Investors with a short time horizon are selling yen because they worry (a) Takaichi favors a weak exchange rate and (b) her ambitious fiscal spending plans will run afoul of the bond market as Tokyo adds to the biggest debt burden in the developed world.

The sense is that, given Takaichi’s priorities, the Bank of Japan will have less latitude to continue hiking rates despite 3% inflation. Also, after a soft 5-year bond sale this week, the so-called “bond vigilantes” are circling. In recent months, markets have buzzed about a “Liz Truss moment” in Tokyo.

Markets know that “Takaichi is a dove on both the fiscal and ‍monetary fronts, so fiscally she would be very comfortable with a looser, higher deficit policy,” says Eric Theoret, strategist at Scotiabank. Masahiko Loo, strategist at State Street Investment Management, adds that the snap drama could mean higher Japanese government bond yields, a weaker yen and strength in equities.

Yet taking a longer-term view, Takaichi’s plan to revive the economic strategy championed by her mentor, Shinzo Abe, is eliciting more eye rolls than enthusiasm.

Abe, prime minister from 2012 to 2020, came and went with few major reforms to his name. His tenure did indeed see Japanese companies strengthen governance, sending stocks to all-time highs. But Abe’s failure to make good on structural reform pledges explains why wages today lag inflation.

Had Abe used high approval ratings early on to cut bureaucracy, make labor markets more meritocratic, rekindle innovation, raise productivity, narrow the gender-pay gap and lure more top global talent to Tokyo, the economy might be less vulnerable to US tariffs.

The question is this: if the late Abe couldn’t recalibrate growth engines and set the stage for Japan to produce more “unicorn” startups, why does Takaichi think she can succeed using the same playbook in a far more difficult global environment?

Even if the LDP’s gamble works and gives Takaichi an outright majority in the lower house, the party will still be in the minority in the upper house. This will make legislating hard. Though it’s still early days for the Takaichi government, 86 days in power should be enough to lay out a reform plan. We’re still waiting.

Takaichi has unveiled plans for a $770 billion spending package. She’s talked in generalities about boosting growth and tackling the rising cost of living. Just like every leader Japan saw come and do with a blur over the last 20 years. The question is how?

Takaichi’s embrace of the “Abenomics” of yesteryear has little to say about improving Japan’s abysmal 28th place productivity ranking among the 38 Organization for Economic Cooperation and Development members. Nor does Takaichi have a plan to give Japan Inc. better odds of catching up with China in both the artificial intelligence and electric vehicle races.

Investors have every reason to worry that “Sanaenomics,” just Abenomics, is mostly trickle-down tactics dressed up as a supply-side upgrade program. Hence, the yen’s drop in recent days — and since the BOJ’s Dec. 19 rate hike.

Though BOJ Governor Kazuo Ueda insists that more tightening is coming, markets aren’t buying it. Not after the economy shrank 2.3% year-on-year in the third quarter. Even if gross domestic product can grow 1.6% this year, as Team Takaichi claims, that would only be half the rate of inflation.

This projection seems to downplay the geopolitical nightmares that lie ahead — from Russia and Ukraine to Iran to the US and the fast-growing list of places in which Trump is hinting at intervening, Venezuela-style, in 2026. Or the reasonable odds that Trump isn’t done slapping tariffs on Asia.

One risk is that Trump, facing declining approval ratings at home, lashes out overseas—particularly Asia. Might Trump realize the extent to which Chinese leader Xi Jinping is dragging his feet on a “grand bargain” trade deal?

Or that Japan is in no hurry to pay even small portions of the US$550 billion “signing bonus” Trump demanded in exchange for a 15% tariff rate. Nor is Korea yet coming up with the US$350 billion payment Trump expects.

Asia hopes the Supreme Court will save it by affirming a lower court ruling that Trump lacks the authority to impose import taxes. Even if the courts stop Trump’s trade war, the White House is already mulling a “game two plan” to impose import taxes in other ways.

One is employing Section 122 of the US Trade Expansion Act, which may allow for tariffs as high as 15% for 150 days in the event of “fundamental international payments problems.” Section 338, meanwhile, might allow for tariffs of up to 50% if Trump can show there’s discrimination against US commerce.

Trump seems to expect he may lose in court. He’s been publicly lobbying Supreme Court justices and warning a ruling against tariffs would be a “terrible blow.” Many worry, too, that Trump would be slow to refund tariff revenue the government has collected.

As economists at TD Cowen point out, US Customs and Border Protection has been “fast-tracking the tariff dollars to Treasury, which puts the question of potential rebates into question.”

Yet Sanaenomics might leave Japan even less equipped to withstand the trade war.

By now, currency traders know the routine surrounding yen weakness. The “Takaichi trade” trade is back. Citibank analyst Ryota Sakagami says further  yen weakness could “trigger concern about inflation and economic deterioration,” weighing on stocks,

In recent days, Japanese Finance Minister Satsuki Katayama hinted at intervention to slow the yen’s decline,  warning of “one-sided depreciation.”In Washington, US Treasury Secretary Scott Bessent urged policy measures in Tokyo to address currency volatility.

“Verbal warnings have helped cap yen weakness for now, but investors are likely to probe authorities’ willingness to follow words with action,” write OCBC FX strategists in a note. “For a more meaningful JPY rally, markets need a hawkish BOJ stance and clarity on Japan’s fiscal and political outlook.”

Takaichi’s desire for a weak yen has economists scaling back BOJ expectations. Last month, Team Ueda raised rates to a 30-year high of 0.75%. That has traders thinking a drop past 160 — perhaps even 170 — is inevitable.

Yet perpetuating the weak yen policy might backfire on Tokyo. It might see Japan importing increased inflation at the moment when it’s already in the neighborhood of 3%, well above the BOJ’s 2% target. It also might enrage Team Trump.

The bigger problem is how it might undermine Japan Inc. but fueling a fresh round of complacency. Many Ministry of Finance bureaucrats and CEOs now realize that a quarter century of manipulating the yen lower did far more harm than good.

It boosted GDP here and fattened corporate coffers. Mostly, though, it deadened the urgency for lawmakers to level playing fields and increase competitiveness. Corporate CEOs had less reason to innovate, restructure, disrupt and boost productivity.

As the International Monetary Fund pointed out in late 2025, “Japan’s total factor productivity growth has been slowing for a decade and has fallen further behind the United States. A steady decline in allocative efficiency since the early 2000s has been a drag on productivity, and likely reflects an increase in market frictions.”

The IMF notes that “Japan’s ultra-low interest rates may have allowed low-productivity firms to survive longer than they otherwise would have, delaying necessary economic restructuring. Reforms aimed at improving labor mobility across firms would help improve Japan’s allocative efficiency and boost productivity.”

Essentially, Takaichi’s plan to boost Japan’s economy is more of the same. It also ignores that Abenomics, which Takaichi is keen to revive, is the reason Japan continues to struggle in the Chinese era.

Follow William Pesek on X at @WilliamPesek