Japan: Leading the pack but behind the curve

What are the key policy pillars of the new administration?

The LDP lost its parliamentary majority in July but has since formed an alliance with the Japan Innovation Party (Ishin) after a split with its long-time coalition partner, Komeito, in October. While the LDP-Ishin alliance falls just short of an absolute majority, some (likely) independent members voted in favor of Takaichi as PM, which led to her having 237 votes out of 465. If they also voted with her on policy matters, the LDP could have an absolute majority. However, it is worth noting that no Ishin party members were given a cabinet position, which implies that the alliance (and the rest of the parliament) may potentially vote on an issue-by-issue basis.

As detailed by the ruling alliance’s policy plan, some key focuses are:

• Inflation: This is the key concern of voters. The alliance has proposed removing the provisional tax on gasoline, along with subsidies for electricity and gas fees. It also discusses the basic deduction from income tax, plus a possible refundable tax credit. It plans to discuss making food and beverages exempt from consumption tax for a limited period of two years. However, balancing these expensive initiatives with budgetary constraints will likely be challenging.
• Energy: The government plans to promote the restart of nuclear power plants, which have largely been switched off since 2011. It plans to accelerate the development of next-generation innovative fission reactors, along with fusion technology. Solar seems to be a relative loser, as there is a focus on regulating large-scale mega-solar projects.
• Defense: The government aims to raise defense spending to 2% of GDP in the current fiscal year (from the 1.8% budgeted this year), ahead of the original fiscal 2027 target. The plan is aimed at strengthening deterrence with a buildout of long-range missiles, next-generation vertical launching system submarines, and rearranging the operational guidelines for transfers of defense equipment.

The near-term resolution implies some political stability with potential for policy execution. The public appears to have high hopes for the administration, with approval ratings between 70-80%, some of the best in decades. The recent first meeting between Takaichi and U.S. President Trump also appeared to yield positive takeaways, with a strong personal relationship established between the two leaders and moderating trade and tariff risks to some extent.

Takaichi’s economic policies (dubbed Sanae-nomics) have been regarded as a spiritual successor to Abenomics (named after the late PM Shinzo Abe, of whom Takaichi is a protégé), which focuses extensively on stimulus. That said, we note that actual policies could be heavily compromised by a fragmented parliament and the inherent fragility of the current coalition. Furthermore, debt sustainability has become a critical concern—a stark contrast to the environment in 2013 when Abenomics was first implemented. Japan now holds the highest government debt-to-GDP ratio among developed economies, exceeding 200% following a decade of unconventional policy stimulus.

With long-end Japanese government bond yields normalizing over the past year, the window for the Japanese government to borrow at negligible cost has closed. The 30-year yield has surpassed 3%, bringing Japan’s funding costs in line with the average for developed markets. This could significantly restrict the scope for further fiscal expansion under Takaichi’s leadership.

Is the Bank of Japan behind the curve?

While Takaichi’s past statements suggest a definitively dovish stance on monetary policy, her new administration has not made substantial statements on that topic so far. However, the BoJ’s independence from political influence has come under question after the recent meeting, where they not only held rates but signaled an even slower pace for policy normalization. The BoJ offered little forward guidance beyond “more data” and kept their economic outlook as before, despite a shifting global economic landscape that has pointed other central banks in a more hawkish direction (especially the Fed). Governor Ueda’s condition for an additional rate hike—focusing on the next spring wage negotiations—also suggests a higher bar for continued policy normalization, meaning the next hike may not be seen until Q1 2026.

In our view, the BoJ appears to be substantially behind the curve based on economic fundamentals. Inflation has remained sticky above the 2% target, and long-term inflation expectations by corporates have picked up. Real interest rates remain deep in negative territory. Persistent price pressure has resulted in an erosion of Japanese households’ real purchasing power, which is one reason the consumption recovery has been slow and bumpy.

In the wake of the dovish BoJ meeting, the yen continued its sharp depreciation since Takaichi’s election, weakening beyond 154 to the dollar to an eight-month high. This raises the risk of a weaker-yen, higher-prices spiral, which is not in the interest of the central bank nor the government. Finance Minister Katayama also recently issued her first verbal warning on the currency. At current levels, USDJPY has already incorporated a significant risk premium from fiscal uncertainties. We think authorities are still incentivized to defend the 160 threshold if they can, but expect the yen to stay relatively weak and volatile. The BoJ may be forced to act in December if we see a sharp weakening in the currency, introducing further currency uncertainty and volatility.

Is it too late to buy Japanese equities?

Japanese equities have been among the best-performing major markets this year in both dollar and local currency terms. However, optimistic market expectations for an aggressive consumption-driven fiscal program will likely need to be tempered due to the competing needs of social welfare and capital investment in defense and tech. In our view, it is too simplistic to conclude that Sanae-nomics is Abenomics 2.0 and position equities as such. Compared to 2013, USDJPY has already halved, meaning the equity tailwind from a weaker yen is mostly behind us. We are also in the fourth year of reflation (vs. deflation), meaning the nominal tailwind to corporate earnings is now expected. While we remain constructive that corporate governance reforms are firmly in place and continue to progress, starting valuations are much richer compared to before and investor expectations have risen. Investors not only want to see growing cash returns, but also strategic focus on reinvesting for growth and improving operating businesses. Aside from optimism regarding a more expansionary fiscal policy backdrop, investors are also pricing in a re-acceleration in U.S. economic growth in mid-2026 and the positive impact this would have on Japanese equities. Much of the positives appear adequately reflected at current index levels.

Investment implications

We remain tactically neutral on Japanese equities given limited upside to our mid-2026 bull case outlook for the Topix at around 3,200-3,300. However, we continue to see room for investors to increase Japanese equity allocations to a neutral allocation of around 5% within a globally diversified equity portfolio. Our implementation preference is for alpha over beta, focusing on specific opportunities within industrials, value-oriented consumer franchises, tech, and financials.

On the currency, we continue to recommend investing in Japanese equities on an FX-unhedged basis, as the inherent long yen exposure could be a natural hedge to FX-driven equity risks and part of a broader USD diversification strategy. Yield enhancement opportunities through structured products are pricing attractively due to higher volatility, though we discourage speculative directional bets on USDJPY given policy and market uncertainties.