The LDP’s landslide victory in the Lower House election has strikingly sparked a different market response than going into the event. Since Takaichi's landslide victory, the 5s30s curve has flattened, traded inflation is stable, and the Yen has strengthened, as the market is now pricing some higher likelihood of shifting portfolio flows and an exit from the exceptionally low real rate regime. We think current conditions can run further given the balance of risks and momentum into a vacuum over the next few weeks, but our bias is that this is potentially ‘too much too soon’. We are not convinced of the market’s characterisation of PM Takaichi as a policy hawk. Market optimism on Japan assets may get a reality check with clarity on BoJ nominations, budget talks. The likelihood of significant repatriation flows also looks low to us over the near term; recent Japanese portfolio flow data and the factors that often take precedence for key investor groups in Japan indicate that, for such flows to occur, we would likely need to see a much narrower rate differential or an even steeper JGB curve. From a flow perspective, last week, USD/JPY recorded the largest downside demand in about a year. 22% of USD/JPY puts transacted post-election featured strikes below 150. JPY still flags as short vs USD in absolute terms, and also relative to peers suggesting more room for short covering. The 1m flow metric is quickly mean-reverting lower after this week, suggesting short covering, and doesn’t suggest the market has pivoted to net long yet. Indeed, JPY still screens as the most-short / least-long currency broadly on the cross-section as well. Summary: To be clear, we do not rule out a further rally in the JPY. The lacklustre reaction in USD-JPY, despite impressive US nonfarm payrolls data, suggests that the JPY has benefitted from market bearishness on US assets. But we also think that Japanese assets may get a reality check once more clarity emerges on BoJ nominations and the fiscal policy stance as budget deliberations resume in early March. Takaichi’s strong mandate could also open the door to unconventional policy measures. For now, the short-term range on JPY still remains 152-160. The stairway towards 140 is still hazy.
