Japan's Ruling Coalition Loses Upper House Majority, Yen Weakens

On Sunday, Prime Minister Shigeru Ishiba’s coalition suffered a significant loss in the upper house election, which could potentially slow down the implementation of new policies and increase the budget deficit. This outcome was already anticipated by investors, who have been closely monitoring the political landscape.

Exit polls from Sunday’s vote indicate that the coalition will lose control of the upper house, resulting in a minority status in both chambers of parliament. This shift in power dynamics could have far-reaching implications for Japan’s economic policies and its ability to navigate ongoing trade negotiations.

With markets closed on Monday for a holiday, the yen could be the first indicator of any fallout from the election results. The currency has already weakened considerably this year as traders anticipate higher taxes and a larger budget deficit. The result, while not entirely unexpected, comes at a critical time as Japan races to secure a tariff deal with U.S. President Donald Trump before the August 1 deadline.

Last week, Japanese government bonds experienced a sharp decline, pushing 30-year yields to record highs. Concurrently, the yen slid to its lowest levels in months against both the U.S. dollar and the euro. This market reaction underscores the heightened uncertainty and potential risks associated with the election outcome.

Rong Ren Goh, a fixed-income portfolio manager at Eastspring Investments, stated, “I will not chase the coalition loss trades. I expect investors to take time to evaluate the results and focus on trade talks, which are another major risk for Japan.” This sentiment reflects the cautious approach many investors are adopting in the face of the political uncertainty.

It remains unclear whether the coalition will attempt to govern as a minority or seek a new partner. One potential ally is the Democratic Party for the People (DPP), which has advocated for the Bank of Japan to reverse its policy and loosen monetary settings. Traders are bracing for the possibility of significant tax cuts to secure opposition support.

Prime Minister Ishiba’s future is also uncertain, although he has indicated his intention to remain in his post. Within the Liberal Democratic Party (LDP), Sanae Takaichi, a supporter of Abenomics and advocate for more Bank of Japan easing, is seen as a likely replacement if Ishiba steps down.

All three main opposition parties support reducing the consumption tax. The right-wing Sanseito party has even suggested phasing out the value-added tax entirely. Any reduction in the consumption levy would necessitate the issuance of more government bonds, further increasing Japan’s already substantial debt, which stands at about two and a half times its GDP, making it the world’s most heavily indebted major economy.

Shoki Omori, chief desk strategist at Mizuho Securities in Japan, noted that preliminary tallies indicate the Liberal Democratic Party–Komeito coalition will retain office only as a minority government. Omori does not anticipate a change in LDP leadership until the U.S. trade talks are concluded. He also predicts that a significant new spending plan is unlikely until the Diet reconvenes in the fall.

If Prime Minister Ishiba resigns, the additional uncertainty could prompt foreign investors to sell Japanese stocks and the yen, according to analysts. Barclays analysts have suggested that a five-point cut in the sales tax from 10% could result in a rise of about 15 to 20 basis points in 30-year bond yields.

Prior to the election, Japan’s bond market was under pressure, with long-term yields rising nearly 1% over the past year. This increase in interest costs, now around 12% of government revenue, has raised concerns about potential credit downgrades. So far this year, 30-year Japanese government bond yields have increased by 80 basis points, and the yield curve is at its steepest in years, with the gap between 10-year and 30-year bonds exceeding 150 basis points.

The yen has traded between 140 and 160 to the dollar in the first half of 2025. It jumped after the Bank of Japan raised rates in January but has barely moved since late April due to political uncertainty, tough tariff talks, and the Bank of Japan’s cautious approach. Traders have heavily bet on the yen, so it could fall quickly if Japan calls a surprise election or eases its budget policy.