Japanese election update - BBH

"Japan's election is three weeks away.  Since last June's UK referendum, through the US election, and more recently, the German election, there have been plenty of political surprises," note economists at BBH.

Key quotes:

"There is little doubt that the LDP will remain the largest party in Japan.  The new national opposition party (Party of Hope) is not fielding enough candidates to secure a majority in the new 465-seat Diet.  Moreover, according to a Kyodo survey, the LDP is drawing support from about 24% of the voters, while the Party of Hope is pulling about 15%.  The survey found 43% were undecided."   

"Abe can still lose by winning.  This sounds like an oxymoron, but there is truth in the assessment.  The LDP has a simple majority (294 seats) and a supermajority (329 seats) with the support of the Komeito Party.   If the LDP loses its simple majority or 61 seats, Abe's political future may be at risk.  His term as LDP head ends in a year and he would likely face a challenger."

"Assuming the LDP remains the largest party in Japan, but Abe is weakened, there would still be increased uncertainty about the trajectory of monetary policy.  BOJ Kuroda's term expires in early April next year.  Typically, the BOJ Governor serves one five-year term.  While a weakened Abe may not be strong enough to resist tradition, it is likely that Kuroda's replacement shares his basic philosophy as opposed to return to the Shirakawa era."    

"We see two main drivers of the dollar-yen rate.  First and most important is the direction of the US 10-year yield.  The correlation between the (percent) change in the US yield and the (percent) change in the dollar-yen exchange rate over the past 60 days appears to be the highest (0.82) since at least 2000.  Second, we pressure on the yen coming from the large dollar premium for yen on a three-month cross currency swap basis.  The dollar premium stands at 49 bp more than LIBOR today, which is the most in seven months.  Recall that at the end of last year, as the dollar traded above JPY118, the dollar premium on the three-month cross currency swap was near 90 bp on top of LIBOR."    

"In the options market, implied vol is jumped around the election (three-week vol is ~9.95%, while the two-week vol is ~8.33%).  With US 10-year yields at the upper end of their six-month range, it should not surprise the dollar is firm against the yen.  A preliminary shelf was carved in the second part of last week near JPY112.20.  Last weeks high was near JPY113.25.  The dollar has run up for near JPY107.30 on September 8, and the technical indicators are stretched.  The Slow Stochastic has already turned lower.  However, the key takeaway here is that the technical indicators of the weekly bar charts suggest a constructive medium-term outlook."