After this weekend, Japanese Prime Minister Shinzō Abe “will have no more excuses,” say Société Générale economists Kiyoko Katahira and Klaus Baader.
Abe’s Liberal Democratic Party (LDP), along with its coalition partner, appears poised to take control of the Japanese Diet’s Upper House after dominating the Lower House elections in December.
With a majority in both houses of the Japanese legislature, Abe will now have a chance to implement the third and most important part of his “Abenomics” program of experimental economic stimulus: long-term structural reform.
The first two components of Abenomics – fiscal and monetary stimuli – have already been put in place by the Bank of Japan and the Abe administration. These measures have already caused a substantial depreciation of the Japanese yen against the U.S. dollar and a concurrent surge in the Japanese stock market, in line with the government’s objectives.
Since late May, however, the Japan rally has faltered, and the dollar has paused in its upward trajectory against the yen. The implication is that financial markets have already priced in the fiscal and monetary measures and are now waiting to see what progress can be made with all-important structural reforms, which will take longer and be more difficult to implement.
Strategists like Makoto Yamashita at Deutsche Bank argue that given the likelihood that LDP takes a majority in the Upper House this weekend, the outcome of the election has already been discounted by financial markets.
“The Upper House election will be held on the 21st, but the market does not seem focused on it,” says Yamashita. “The market appears to be turning its attention to fiscal policy following the election.”
Goldman Sachs equity strategist Kathy Matsui agrees, writing in a note to clients this week, “Since an LDP/Komeito majority is widely expected by investors, the net impact on the equity market would be neutral (or potentially positive if the LDP wins a landslide victory).”
On the other hand, strategists like Société Générale’s Kit Juckes see this weekend’s election as the catalyst for the next big move in the Japan rally.
“Control of both houses would give PM Abe freedom to push through policies that should see the yen weaken significantly further,” says Juckes. “I think the move to USD/JPY 110 starts on Monday.”
(The dollar is currently trading around ¥100.60.)
SocGen’s Katahira and Baader write in a note to clients:
After the upcoming upper house election, there are no scheduled national elections for three years. So, assuming that PM Abe maintains high approval ratings, Japan can look forward to a period of stable, and strong, government. But this also means that the government has no more excuses not to embark on what is likely to prove the hardest bid of Abenomics, namely reforming and restructuring the economy so as to boost its medium- to long-term growth potential, i.e. the so-called third arrow.
Until now, this has remained rather ill-defined, with some heroic goals pronounced, but little in the way of concrete policies of how to get there. Ahead of the upper house election, this was quite understandable, as reforms will undoubtedly challenge vested interests, which Mr Abe would not want to antagonize. But with power consolidated, there can be no more excuses.
Indeed, unless the government aggressively pushes ahead with the third arrow, the honeymoon the Abe administration has enjoyed with both voters and investors may quickly come to an end. It is no exaggeration to say that the third arrow is by far the most important of the lot.
Below is a breakdown of the election maths from the global macro strategy team at UBS:
The LDP and its coalition partner the New Komeito party should win at least a majority of the seats in the country’s upper house election this Sunday. Half of the upper house’s 242 seats are up for election, with 121 seats up for grabs – 44 of which belong to the opposition Democratic Party of Japan (DPJ).
The LDP and new Komeito coalition need to win 63 seats to gain a majority in the upper house. This appears very achievable according to recent public polls. Several media organisations project the LDP-led bloc to garner more than 76 out of the 121-contested seats, which would constitute an “absolute stable majority.” This would allow the LDP to effectively control all of the major committees in the upper house as over 50% of the committee members would come from the LDP and all major committee chairmen would also be appointed by the LDP.
This coupled with the LDP-led coalition majority in the lower house would give them an unchallenged hold over policymaking. Also note that if the LDP can win 72 seats on its own then it will have a single-party majority in the upper house that would leave it less dependent on its coalition partner the New Komeito party.
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