Markets expected Japan’s ruling party loss

On Sunday, Prime Minister Shigeru Ishiba’s coalition suffered a big loss in the upper house election. That setback could slow new policies and increase the budget deficit, outcomes investors have already anticipated.

Exit polls from Sunday’s vote show the coalition will lose control of the upper house and end up in the minority in both chambers of parliament.

Because markets are closed on Monday for a holiday, the yen could be the first sign of any fallout according to Reuters. The currency has already weakened a lot this year as traders bet on higher taxes and a bigger budget deficit.

The result, while not a total surprise, comes as Japan races to secure a tariff deal with U.S. President Donald Trump before the August 1 deadline.

Last week, Japanese government bonds fell sharply, pushing 30‑year yields to record highs. At the same time, the yen slid to its lowest levels in months against both the U.S. dollar and the euro.

“I will not chase the coalition loss trades,” said Rong Ren Goh, a fixed‑income portfolio manager at Eastspring Investments. “I expect investors to take time to evaluate the results and focus on trade talks, which are another major risk for Japan.”

Uncertainty around coalition’s next move

It may take a while before it’s clear whether the coalition will try to govern as a minority or team up with a new partner.

One possible new ally is the Democratic Party for the People (DPP), which has urged the Bank of Japan to reverse policy and loosen monetary settings. Traders are braced for the LDP to agree to big tax cuts to win opposition support.

Ishiba’s own future is still up in the air, though he said on Sunday he plans to stay in his post. Inside the LDP, Sanae Takaichi—an Abenomics backer who favors more BOJ easing—is seen as a likely replacement if he steps down.

All three main opposition parties support cutting the consumption tax. The right‑wing Sanseito party has even suggested phasing out the value‑added tax entirely.

Any cut in the consumption levy would have to be paid for by selling more government bonds. With debt at about two‑and‑a‑half times GDP, Japan is already the world’s most heavily indebted major economy.

“Preliminary tallies indicate that the Liberal Democratic Party–Komeito coalition will retain office only as a minority government,” Shoki Omori, chief desk strategist at Mizuho Securities in Japan, wrote in a note.

Omori said he doesn’t think the LDP will change leaders until the U.S. trade talks finish. He said a big new spending plan probably won’t come until the Diet meets again in the fall.

Ishiba’s resignation could trigger market moves

If Ishiba resigns, that extra uncertainty could push foreign investors to sell Japanese stocks and the yen, analysts warn.

Barclays analysts say that if the sales tax is cut by five points from 10%, 30‑year bond yields would rise by about 15 to 20 basis points.

Ahead of the key vote, Japan’s bond market was under pressure, with long‑term yields already rising nearly 1% over the past year. This has raised credit downgrade concerns as interest costs climb to around 12% of government revenue

So far this year, 30‑year JGB yields are up 80 basis points, and the yield curve is at its steepest in years, with the gap between 10‑year and 30‑year bonds over 150 basis points.

The yen has traded between 140 and 160 to the dollar in the first half of 2025. It jumped after the BOJ raised rates in January but has barely moved since late April because of political uncertainty, tough tariff talks, and the BOJ’s cautious approach.

Traders have bet heavily on the yen, so it could fall quickly if Japan calls a surprise election or eases its budget policy.

Meanwhile, the Nikkei 225 has risen over 11% since April 2, when President Trump announced his global tariff plan.

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