The Nikkei 225's Recent Record High and the Impending Shift in Japan's Fiscal Policy

Japan’s financial markets are at a crossroads. The Nikkei 225 and Topix indices surged to record highs in early September 2025, driven by speculation that the Liberal Democratic Party (LDP) will pivot toward expansionary fiscal policies following Prime Minister Shigeru Ishiba’s abrupt resignation [3]. Sanae Takaichi, a leading contender for the LDP leadership and a vocal proponent of “Abenomics 2.0,” has positioned herself as a champion of aggressive government spending and ultra-easy monetary policy [1]. While her agenda could supercharge equities in the short term, it raises critical questions about Japan’s long-term debt sustainability and the stability of its bond markets.

Takaichi’s Fiscal Vision: A Return to Abenomics?

Takaichi’s policy platform is rooted in a continuation of the fiscal and monetary stimulus pioneered under former Prime Minister Shinzo Abe. According to a report by Bloomberg, she has explicitly opposed Bank of Japan (BOJ) rate hikes and advocated for increased public investment in infrastructure, healthcare, and green energy [1]. This aligns with Modern Monetary Theory (MMT) principles, emphasizing deficit spending to stimulate growth regardless of debt levels [3].

Historically, Abenomics—a mix of aggressive monetary easing, fiscal stimulus, and structural reforms—initially boosted Japan’s equity markets but also pushed public debt to over 250% of GDP, one of the highest ratios globally [4]. Takaichi’s proposals suggest a willingness to tolerate even higher deficits to fuel reflationary momentum. Market analysts warn that while this could temporarily buoy stocks, it risks exacerbating inflationary pressures and straining an already fragile bond market [2].

Market Reactions: Equities Rally, Bonds Retreat

The Nikkei 225’s record high reflects investor optimism about Takaichi’s potential to implement pro-growth policies. However, the bond market tells a different story. The 30-year JGB yield spiked to 3.285% in early September—the highest level since the 1990s—as traders priced in the likelihood of increased government borrowing and delayed BOJ rate hikes [1]. This divergence between equity and bond markets underscores the tension between reflationary bets and concerns over fiscal sustainability.

The yen’s sharp depreciation to 148.36 per U.S. dollar further illustrates the market’s skepticism. A weaker yen could amplify inflation, forcing the BOJ into a delicate balancing act: maintaining accommodative policy to support growth while avoiding a spiral of rising bond yields and currency instability [5]. Overnight index swaps now price in a near-zero probability of a BOJ rate hike in October, signaling diminished confidence in the central bank’s ability to normalize policy under a Takaichi-led administration [1].

Risks and Challenges: Debt, Deflation, and Global Spillovers

Japan’s public debt, already a staggering 250% of GDP, remains a critical vulnerability. The International Monetary Fund (IMF) has historically urged fiscal consolidation, including a gradual increase in the consumption tax, to stabilize debt dynamics [2]. Takaichi’s pro-stimulus stance directly contradicts this advice, raising fears of a prolonged debt-driven growth model that could erode investor confidence.

Moreover, Takaichi’s policies risk reigniting the “liquidity trap” dynamics of the 2010s, where aggressive monetary easing failed to generate sustained inflation but instead inflated asset prices while leaving real wages stagnant. If history repeats, the Nikkei’s current rally could prove ephemeral, with gains concentrated in sectors like construction and finance rather than broad-based economic revival.

Conclusion: A High-Stakes Gamble

Sanae Takaichi’s potential leadership represents a high-stakes gamble for Japan’s markets. While her pro-stimulus agenda could provide a short-term tailwind for equities, the long-term implications for bond markets and fiscal stability are far less certain. Investors must weigh the allure of reflationary growth against the risks of a debt-fueled policy path that mirrors the challenges of the past two decades.

As Japan braces for a new era of fiscal expansion, the coming months will test the resilience of both its markets and its policymakers. The Nikkei’s record high is a sign of hope, but the path forward remains fraught with uncertainty.

**Source:[1] Japan's Long Bonds Drop as Ishiba Resignation Fuels Fiscal Risk [https://www.bloomberg.com/news/articles/2025-09-08/japan-s-long-bonds-drop-as-ishiba-resignation-fuels-fiscal-risk][2] Asia [https://www.cfr.org/asia?_wrapper_format=html&field_publication_type=All&page=225&regions=All&sort_by=field_display_date_value&sort_order=DESC&theme_view=normal&topics=All&type=All&wptouch_redirect=blogs.cfr.orgasia20111026sick-man-of-east-asiabeijing-cancer-hospital-operation][3] Sanae Takaichi - NamuWiki [https://en.namu.wiki/w/%EB%8B%A4%EC%B9%B4%EC%9D%B4%EC%B9%98%20%EC%82%98%EB%82%98%EC%97%90][4] Japan's stressed bond market, stocks brace for PM Ishiba ... [https://m.economictimes.com/markets/bonds/japans-stressed-bond-market-stocks-brace-for-pm-ishiba-exit-reaction/articleshow/123758924.cms][5] Asian stocks gain on rate cut optimism, yen dives after Ishiba ... [https://economictimes.indiatimes.com/markets/stocks/news/asian-stocks-gain-on-rate-cut-optimism-yen-dives-after-ishiba-resigns/articleshow/123755176.cms?UTM_Campaign=RSS_Feed&UTM_Medium=Referral&UTM_Source=Google_Newsstand]