Japanese Election Uncertainty May Halt U.S. Trade Talks, Spark 25% Tariff

As the Japanese House of Councillors election approaches, the ruling coalition's chances of losing its majority in the upper house are increasing, according to a report by Nomura. This potential loss could lead to the resignation of the prime minister, a halt in U.S.-Japan trade negotiations, and a 25% tariff on Japanese imports.

Nomura's report, released on July 14, highlights that with just a week left until the election, the ruling coalition's seat count is expected to decline. This could result in the prime minister's resignation, a pause in U.S.-Japan trade talks, and a delay in interest rate hikes by the Bank of Japan. The report also notes that the ruling coalition's seat projections have been steadily decreasing, with recent polls suggesting they may fall short of the 50 seats needed to maintain a majority.

If the ruling coalition fails to secure a majority, the prime minister may step down, potentially halting the crucial U.S.-Japan trade negotiations. This could make it nearly impossible to complete the talks by the August 1 deadline. The report warns that the U.S. may increase tariffs on Japanese imports to 25%, which could negatively impact Japanese exporters' profits.

In the event of a change in government, Nomura predicts that the potential new administration may adopt a more accommodative fiscal policy. This could include measures to boost household disposable income, such as increasing welfare benefits, reducing social insurance premiums, and eliminating temporary fuel tax increases. The report suggests that the ruling coalition, even if it loses its majority, could still form a government, as the lower house has the final say in electing the prime minister.

Nomura's analysis indicates that a defeat for the ruling coalition could have a mixed impact on the stock market. While political uncertainty and the interruption of U.S.-Japan talks could weigh on market sentiment, the potential for fiscal stimulus and a delay in interest rate hikes by the Bank of Japan could provide support. The report also notes that a delay in rate hikes could lead to a depreciation of the yen against the dollar, benefiting export-oriented sectors but putting pressure on financial stocks.

As the election nears, traders have been increasing their short positions on the yen. The options market has seen a significant increase in the trading volume of dollar-yen call options, with calls outpacing puts by more than double on July 11. Analysts attribute this to concerns over the lack of progress in U.S.-Japan trade talks and fiscal worries, which are "deteriorating market sentiment towards the yen."