How will the appointment of Japan’s new prime minister affect the markets?

Author: Mario Montagnani, Senior Investment Strategist, Vontobel

Shigeru Ishiba's unexpected victory in the Liberal Democratic Party of Japan's leadership race signals a possible shift in ‘Abenomics’ policies. His support for monetary policy normalisation and higher corporate taxes could significantly affect Japan's financial landscape. Investors are rethinking the outlook for Japanese equities and the yen carry trade. They are considering how changes in interest rates, currency values and fiscal policies could reshape investment strategies and market dynamics in the near future.

How will Ishiba's economic policies influence Japanese equities and the yen carry trade in the coming year?

We believe that the policy agenda of Japan's incoming Prime Minister Shigeru Ishiba may impact Japanese equity markets, as well as the yen carry trade, in a number of ways.

We believe that his emphasis on structural reforms - in particular the revitalisation of rural areas - is not in line with the pro-growth ‘Abenomics’ approach that has underpinned Japanese stock markets in recent years. Indeed, Ishiba has in the past been highly critical of the Bank of Japan's aggressive monetary easing. As a result, we believe that investors may be more cautious about this change in the Japanese political landscape. This could lead to volatility and even a possible market correction in the short term, especially if expectations of aggressive monetary stimulus diminish. Importantly, Ishiba himself recently played down speculation on this issue. Indeed, over the weekend he stressed that Japanese monetary policy is expected to remain accommodative, which in a sense implies a willingness to keep borrowing costs low to underpin still fragile economic growth.

On the other hand, the possibility of Ishiba's shift towards a more normalised monetary policy could raise the possibility of rate hikes, which in our view would probably strengthen the yen. This could make the ‘yen carry trade’, a strategy where investors borrow yen to invest in higher-yielding asset classes, less attractive. A stronger yen would reduce the profitability of this strategy and traders may start to unwind short yen positions. We have already had a taste of this last August. Finally, a stronger yen could hurt export activities to which Japan is structurally linked.

To sum up, despite the reassuring words of the last few hours, the arrival of the new prime minister, Shigeru Ishiba, leads us to believe that the stock market may experience some pressure and volatility due - among other factors - to lower growth expectations. In addition, the yen could appreciate, affecting carry trades and more diverse financial strategies. Developments in the Japanese equity market these days tend to support our reasoning.