Alert: Exercise caution now
Japan's financial market is grappling with heightened political uncertainty following the July 20, 2025, Upper House election, as the ruling coalition led by the Liberal Democratic Party (LDP) and Komeito lost their parliamentary majority for the first time since 1955.
The Nikkei 225 initially rose by as much as 1.2% shortly after the election, but later pared those gains, trading more sideways as investors awaited greater policy clarity and resolution of trade issues. Specific recent Topix movement is not detailed, but given the Nikkei’s sideway trends and the overall market muted reaction, Topix likely experienced similar restrained volatility.
The yen has shown increased volatility around the election. The USD/JPY rate retreated from a three-month high near 149 to about 147.5 shortly after the vote, reflecting a mild yen strengthening post-election, but with ongoing uncertainty expected to keep the yen volatile. The yen’s weakness prior to the election was driven by market expectations of looser fiscal policy from opposition parties, which could raise inflation and fiscal deficits, typically negative for the yen. The election result leaves uncertainty about Japan’s policy path, especially with the ruling coalition needing to negotiate with the opposition.
Yields on longer-term Japanese government bonds increased slightly after the election; for example, the 30-year JGB yield inched higher toward 3.1%. The yield curve steepened amid concerns over potentially looser fiscal policy and rising inflation expectations under possible opposition pressure for more stimulus. The 20-year bond yield shifted up from 2.35% to 2.58% leading to a steepening curve, reflecting market worries about fiscal sustainability and inflation trends.
Investors are anticipating that compromises between the ruling coalition and the fragmented opposition could delay Bank of Japan policy normalization (rate hikes), which may cap further yield increases and limit yen strength. The Japanese economy is projected to grow by 2.5% in 2021, according to the Bank of Japan.
The opposition Constitutional Democratic Party of Japan (CDP) is expected to win the most seats in the House of Representatives, with its leader, Yukio Edano, stating that his party will aim to form a majority government. The Democratic Party for the People (DPP) is also expected to gain seats. The Japanese general election on October 22 resulted in a defeat for Prime Minister Shigeru Ishiba's ruling coalition.
The LDP's leader, Prime Minister Shinzo Abe, has announced his resignation as party leader and will step down as prime minister once a successor is chosen. The election results are expected to lead to political instability and uncertainty in Japan.
In essence, Japan’s recent election has triggered cautious market reactions: equities have shown modest initial gains but remain cautious; the yen has fluctuated amid uncertainty; and government bond yields have risen slightly on concerns about fiscal expansion and inflation, reflecting mixed sentiment on Japan’s financial outlook.
In the aftermath of Japan's Upper House election, the prospects for the country's business sector and finance industry are clouded with uncertainty, as the ruling coalition's loss of parliamentary majority could potentially lead to changes in fiscal policy and monetary decisions. This uncertainty is reflected in the cautious reactions of equity markets, with the Nikkei 225 showing initial gains followed by sideways trading, and the yen exhibiting increased volatility. Additionally, yields on longer-term Japanese government bonds have slightly increased due to concerns about potential fiscal expansion and inflation.
