Yen plunges to 18-month low on snap election speculations

Political clarity emerges as Takaichi weighs snap election

The Nikkei 225 surged over 3% to record highs whilst the yen declined to its weakest level in 18 months against the dollar on Tuesday, as markets digested Prime Minister Sanae Takaichi's consideration of a snap election as early as February following a long weekend.

The ruling Liberal Democratic Party (LDP)-Japan Innovation Party (Ishin) coalition currently holds a position several seats short of a Lower House majority. Whilst the coalition secured support from three independent lawmakers in November to pass key legislation, this arrangement lacks the stability that a formal majority would provide. Takaichi's high approval ratings of approximately 70% present a substantial probability for the coalition to gain additional seats in the Lower House.

Japanese equities rally on multiple tailwinds

The prospect of a snap election presents asymmetric risk skewed towards the upside for Japanese equities over the medium term. Should the LDP-Ishin coalition gain greater control over the Lower House, this would deliver much-needed political stability in Japan -- critical for sustaining both foreign and domestic investor confidence in a market trading at over one standard deviation above its 10-year average price-to-earnings ratio.

Shares of companies falling under the 17 strategic development areas identified by Takaichi, including defence and artificial intelligence, recorded the strongest gains on Tuesday. Lasertec advanced 9%, Kawasaki Heavy Industries gained 8%, and Advantest rose 8%, ranking amongst the best-performing Nikkei 225 constituents.

Potential downside risks remain, particularly concerning delays in passing the budget by the 1 April deadline. Should the LDP underperform expectations despite Takaichi's popularity, renewed political gridlock would prove a significant headwind for equities at current elevated valuations.

Beyond political developments, Japanese equities are benefiting from a weaker yen enhancing export competitiveness. Toyota Motor advanced 7% intraday at the time of reporting.

Foreign investor positioning has strengthened significantly, with 2025 witnessing the highest annual net buying since 2013 at approximately $38 billion. The combination of potential improvements in political stability and significant progress on corporate governance reforms have enhanced Japan's appeal. However, this enthusiasm remains conditional -- any election disappointment or policy missteps could rapidly reverse these flows given the limited valuation cushion at current levels.

From a technical perspective, the Japan 225 index exhibits dominance by a strong uptrend, and given the decisive breakthrough of November's record high, the index displays extremely robust momentum. That said, the relative strength index (RSI) is reflecting signs of overbought conditions. The index has not experienced a correction exceeding 9% since the April sell-off, suggesting a pullback may be overdue. We would be more comfortable initiating long positions should the index retreat towards the support trendline at approximately 52,200 -- 52,300.

Japan 225 index daily price chart

USD/JPY approaches intervention threshold

Whilst Japanese equities rally, the yen's weakness has extended as a more powerful Takaichi administration may translate into larger fiscal spending and further delays in the normalisation of the Bank of Japan's (BOJ) monetary policy. USD/JPY surged to 158.91, a level last observed on 12 July 2024 when the Japanese government deployed ¥3.2 trillion to support the domestic currency.

Finance Minister Satsuki Katayama has already expressed concerns regarding the yen's rapid one-sided movements in recent months and emphasised that foreign exchange intervention remains possible. However, despite the verbal guidance, there is no indication of actual intervention even though USD/JPY approached the 158 level on several occasions since October.

What renders this particularly noteworthy is that USD/JPY strength emerges despite broader dollar weakness following the Department of Justice's probe into Federal Reserve Chair Jerome Powell.

Over the medium-to-long term, barring significant escalation in Federal Reserve independence concerns, USD/JPY should remain anchored to fundamentals -- interest rate differentials and relative economic performance. A gravitational pull towards 146 -- 148 by year-end appears reasonable. However, near-term headwinds persist: the Bank of Japan's lack of clear guidance on its rate hike schedule, combined with uncertainty surrounding election timing, will likely maintain pressure on the yen.

Any dollar weakness from current levels would be supported technically at around 155. This creates a relatively narrow USD/JPY trading range in the near term, bounded by potential intervention concerns above and technical support below.

USD/JPY daily price chart

Bank of Japan trapped in policy corner

The BOJ faces an increasingly uncomfortable position. Inflation running above the 2% target suggests policy normalisation is warranted, yet the economy remains fragile and yen weakness creates import cost pressures. Governor Kazuo Ueda has emphasised patience and data dependency, but this cautious approach is losing credibility amongst market participants.

The absence of clear guidance on the rate hike schedule leaves markets without direction. Whilst flexibility allows the BOJ to respond to developments, it generates uncertainty that weighs on the yen. Spring wage negotiations in March will provide critical input -- strong wage growth would support normalisation, whilst weak outcomes would justify continued patience despite above-target inflation.

The global monetary policy environment constrains BOJ options. With wide interest rate differentials between Japan and other developed markets, each BOJ decision carries consequences for currency markets and carry trade dynamics. The central bank's gradualism may prove sensible for domestic economic stability, but it perpetuates yen weakness that increasingly concerns policymakers.

Election uncertainty adds another complication. Should Takaichi call a snap election, the political calendar will dominate headlines through mid-February. This overhang makes it difficult for the BOJ to shift its policy stance, as authorities typically avoid major decisions during campaign periods. Policy clarity may need to await political clarity.

Bond yields spike on fiscal sustainability concerns

The sharp rise in long-dated government bond yields is driven primarily by concerns over Takaichi's fiscal expansion plans; such concerns have been magnified with the snap election prospect. The 10-year yield reached 2.16% whilst the 20-year yield reached 3.14%, their highest levels since 1999.

Market participants are increasingly focused on fiscal sustainability following approval of a record ¥122.3 trillion budget for fiscal 2026. The government plans ¥29.6 trillion in new bond issuance to fund this expansion, raising supply concerns despite plans to reduce super-long bond offerings commencing in April. Japan's debt-to-gross domestic product (GDP) ratio stood at 237% according to the International Monetary Fund in 2024, the highest amongst G10 nations. Debt servicing costs are projected to reach ¥31.3 trillion in fiscal 2026, up from ¥28.2 trillion in fiscal 2025.

Japanese 20-year government bond yield

• _{The figures stated in this article are as of 2.30pm HK time as of 13 January 2026 unless otherwise stated. Past performance is not a reliable indicator of future performance.}