Major Political Change Coming In Japan

Japan will hold a national election on August 30th. For most of the last 50 years the conservative LDP party has ruled Japan. This is likely to change come August 30th with the Democratic (DPJ) party expected to win the election. The most recent Japanese election polls show that the opposition DPJ party will win the election ending the LDP's half century rule. The recession and numerous scandals have hurt the LDP's popularity and like the US electorate last fall, Japan's voters want change. The only question now is how large the DJP majority will be in Japan's congress. Let's take a look at how the Japanese election may impact the Japanese markets the BOJ and JPY.

DPJ pledges to boost domestic demand

The Japanese economy remains highly dependent on export growth. The ruling LDP party has been a major proponent of export led growth and supporter of Japan's business and industry. The DPJ party platform is focused on spending plans to boost domestic growth and try and reduce Japans dependence on exports. Japans exports declined 35.7% in July. If elected the DPJ focus on domestic growth would be a major shift from the LDP's focus on support of business and industry. The DJP party plans to increase spending to boost domestic growth. The DPJ has made election promises to pay cash allowances of more than $3000 per child for families, make high school tuition free and provide more social programs along with postponing a hike in the country's consumption tax. Tuesday, Japan's Finance Minister Yasano warned that Japan's already strained fiscal outlook would not allow the DJP to carry out its spending plans. Japan's government debt already tops 170% of GDP. The DPJ party has not indicated how they plan to pay for their plans and increased government spending in Japan could lead to higher bond yields. Wednesday, the Wall Street Journal reports that the DJP party is talking down spending plans. A number of analysts have concluded that DPJ party could fund its spending plans without serious risk to the JPY or bonds.

DPJ may buy less US bonds and boost relations with Asia

The leader of the DPJ party has said that if he is elected Japan would no longer look to buy US denominated bonds and would only buy JPY nominated bonds. The Japanese election could have significant impact on the financing of the US budget deficit as Japans current government is a major buyer of US bonds. The DPJ party leader has expressed concern about what he labels US 'unilateralism.' The election change may also mean that Japan would be less supportive of USD reserve status. 70% of Japanese currency reserves are reported to be held in USD. It's not clear that the DPJ pledge to boycott US bonds will come to pass or is practical. The new Japanese government will not want to undermine its large holding of USD with any significant shift out of the USD. This is particularly true because there are limited reserve currency alternatives to the USD. The DPJ party also plans to shift focus away from trade relations with the US and seek to build relations within Asia. Expanding trade with the Asian block is likely to be a positive for Japan's economic outlook and it's unlikely that US Japanese relations would deteriorate because of an effort Japan to expand export trade with Asia. China recently became Japans leading trading partner.

DPJ critical of BOJ policy

The DPJ election victory may also have impact on BOJ policy outlook. The DJP has been critical of BOJ policy and some party members want the BOJ to take more aggressive action to boost domestic growth. Other DPJ members have criticized the BOJ low yield policy because low interest rates hurt older Japanese who rely on interest income. The DPJ however is expected to respect BOJ independence and accommodative BOJ policy because of uncertain outlook for the global economy and the need for BOJ support for Japan's economy. BOJ interest rates are expected to be held at 0.1% until 2011. A DPJ victory is unlikely to change BOJ rate outlook.

Nikkei trades at a 10 month high

The Japanese stock market has been rallying in front of the election supported by speculation that a DPJ party victory would be positive for Japan's domestic growth and could pave the way for needed reforms if the election breaks the current deadlock in Japans congress. Recent economic data from Japan suggests that Japan's economy has stabilized and the recession ended in the second quarter. The improvement in the Japanese economy has come too late to help the LDP party. Although there is likely to be a major political change this weekend the impact of the election should be limited for the Japanese markets and JPY. The Japanese stock market is rallying, the JPY is stable and bond yields have risen slightly in front of the election. The biggest concern that may arise from Japan's election is the potential of increased budget spending which could lead to rising interest rates. The DPJ is unlikely to move too far away from Japan's long held reliance on weak JPY to stimulate exports. If the DPJ shifts focus to the domestic economy away from export led growth the new government may eventually tolerate a stronger JPY. Any major shift away from the purchase of US bonds is impractical. It will be interesting to watch how the DPJ party handles the issue of USD reserve status. The DJP is unlikely to press on the issue of USD reserve status because of Japan's large holdings of USD reserves. As the Obama administration finds rising budget deficits may become a roadblock to some spending plans, the new Japanese government may experience a similar reality. The Japanese election should have limited short term impact on Japanese markets, the BOJ or JPY.

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