Under the power vacuum, Japan sees a major shift in investment logic! Global funds are focusing on the weak yen and fiscal expansion.

Japanese financial giant Nomura recently released a research report stating that the political and fiscal policy prospects for Japan in 2025 and early 2026 can be clearly assessed through the "seven core steps". Nomura has provided short-term risk-averse strategies for global funds during Japan's power vacuum period, strategies for the game during the prime ministerial election and fiscal risk events, and medium to long-term layout strategies after policy clarity based on these seven steps and Japan's political and fiscal prospects. The composition of the ruling coalition in Japan may have a significant impact on future fiscal management, but due to the difficulty in accurately predicting the specific party of the future ruling coalition, Nomura has not included these governing factors in the institution's economic forecasts; in the scenario of a larger scale or longer-term consumption tax reduction, Nomura's strategy team believes that yields and exchange rates may react. Overall, Nomura believes that the future political developments in Japan are unlikely to affect the policy stance of the Bank of Japan. However, Nomura also acknowledges that until a new government takes office and formally begins policy formulation, there will be considerable uncertainty in the expectations of all financial institutions. If the Bank of Japan decides to incorporate the significant uncertainty brought about by this new ruling coalition into its monetary policy model, the likelihood of a rate hike by the Bank of Japan in October will decrease, and Nomura's baseline scenario is that the next rate hike by the central bank will be in January 2026. Regarding the global fund's short-term risk-averse strategy during Japan's power vacuum period, Nomura recommends selling cyclical stocks (such as large industries/automobiles/machinery) and increasing holdings in defensive sectors (healthcare/necessities); during a major event game, Nomura suggests going long on 10-year Japanese government bond futures (betting on a delay in the Bank of Japan's rate hike) and shorting the yen (the USD/JPY may surge to the target of 155-158, indicating a significant devaluation of the yen). As for the medium to long-term layout strategy, Nomura recommends focusing on bank stocks (benefiting from interest rate normalization), leading semiconductor equipment manufacturers (which will benefit from the ongoing global AI frenzy even after political and fiscal clarity, and chip giants like TSMC expanding chip manufacturing capacity in the face of tariff pressure), and consumer leaders (potential beneficiaries of domestic stimulus policies that the future Japanese government may implement and potential consumption tax reductions). Japan is about to enter a power vacuum period On September 7, Prime Minister Yoshihide Suga officially announced his intention to resign as president of the Liberal Democratic Party in a press conference. He gave two main reasons for the timing of his resignation: first, Japan had made some progress in tariff negotiations with the United States, especially President Donald Trump officially signing an executive order on September 4 to lower import tariffs on Japanese cars to 15%; second, the LDP had been considering holding an early party leadership election (based on Article 6-4 of the party rules), which would avoid an unprecedented "dismissal" and "settlement" procedure for Suga as party leader. Otherwise, he would have to take responsibility for internal party divisions. Regarding the timetable for Suga's formal resignation: it is highly probable that he will step down in early October; whether it will be a month or two weeks depends on the form of the party leader election. In his press conference, Suga stated that the timing of his resignation would depend on when the LDP holds its internal vote. In other words, the resignation date is related to the timing of the party leader election, and he also stated that he had no say in the election schedule. According to Article 6-2 of the LDP's rules, when a party leader resigns in the middle of their term (as in the current situation), a party leadership election should be held in principle. The party rules do not have strict rules on the form of the election, but Nomura's strategy team has narrowed the scenario down to two possible timelines: The first is the normal procedure. This refers to a vote by a total of 295 LDP parliamentarians (members of both houses) and three representatives each from the 47 prefectural branch union associations (a total of 141 seats). In this case, there would be a campaign period of at least 12 days, so the election is expected to take place roughly a month later (for example, on October 4). In other words, Suga is expected to resign about a month later. The second is an election under simplified rules. This involves a vote by 295 LDP parliamentarians and three representatives each from the 47 prefectural branch union associations (a total of 141 seats). Unlike the normal procedure, voting is done at a joint meeting of members of both houses, not at a party congress. Article 6-2 of the party rules states that simplified rules can be used "in special emergency circumstances." If the simplified rules are used, the leadership election is expected to take place faster than the normal processroughly two weeks later (for example, in the last week of September). In other words, Suga may step down in about two weeks, and the following period until a new prime minister is elected will be a power vacuum period in Japanese politics. Next is the discussion of whether the LDP is more likely to adopt normal or simplified procedures. Considering the series of setbacks in the October 2024 Lower House election, the June 2025 Tokyo Metropolitan Assembly election, and the July 2025 Upper House election, the government faces pressure to rebuild public trust. This makes it more likely that the party will choose the normal process for the leadership election, as it gives more voting rights to party members of parliament and the 47 prefectural branch union representatives. In other words, this will narrow the time difference between "quickly advancing the leadership election and having Suga step down soon" and "postponing it until early October". However, if the simplified procedure is adopted, it will force the government to delay policy progress (including drafting the supplementary budget for the 2025 fiscal year). What's next: seven steps In Nomura's view, the following seven steps will be key to assessing the future political and fiscal policy prospects in Japan in the remaining time of 2025. LDP party leader vote: when will it take place, and who might win? As mentioned earlier, there are two possible timelines for the party leadership election: normal procedures or simplified rules. Nomura believes the former is more likely. Currently, no LDP members have officially announced their candidacy, but some popular candidates mentioned by the public include: Sanae Takaichi (former Minister of Economic Security), Shinjiro Koizumi (former Minister of Agriculture, Forestry and Fisheries), Yoshihide Suga (Chief Cabinet Secretary), Takanori Kobayashi (former Minister of Economic Security), and Toshimitsu Motegi (former Secretary General of the LDP). The focus is mainly on Takaichi and Koizumi, who ranked second and third in the LDP leadership election in September 2024, losing to Suga. A key point in this internal vote is who supporters of Suga will vote for. Given that the day before his resignation was announced (on September 6), Suga met with Deputy Prime Minister Yoshihide Suga (former Prime Minister) and Koizumi, and Yoshihide Suga has a close relationship with Koizumi, Nomura's strategy team believes that Suga's support base may shift to Koizumi. Under the leadership of the new LDP president, how might the composition of the ruling coalition change? After the new party leader is elected, Nomura believes that the existing ruling coalition (LDP+Komeito) will consider how to cooperate in the future, including the option of absorbing one or more opposition parties into the cabinet to maximize the lost seats in both houses. Maintaining the status quo means continuing to maintain the LDP/Komeito two-party structure. However, this will keep the government in a minority government form and make policy progress more difficult. Nomura also believes that the government may choose to expand the alliance by including parties like "Nippon Ishin no Kai" from the opposition. This is likely to trigger market speculation about a possible consumption tax cut and other expansionary fiscal policies. However, as long as the LDP remains in power, Nomura believes that a significant reduction in the consumption tax is still unlikely; the baseline scenario for Nomura does not include tax cuts. Who will become the new prime minister? After the LDP selects a new party leader, the Japanese parliament will convene an extraordinary election meeting a few days later (if following normal procedures, most likely in the week of October 6) to elect a new prime minister. The nomination and election of the new prime minister may be significantly influenced by the composition of the ruling coalition. However, Nomura emphasizes that, although unlikely, if an opposition party joins the ruling coalition and collectively demands that it choose the prime minister, the possibility cannot be ruled out that the new LDP president will not be elected as prime minister. How will the supplementary budget for the 2025 fiscal year be? After electing a new prime minister and forming a new cabinet, an extraordinary session of the parliament will be held to draft the supplementary budget for the 2025 fiscal year. The budget is likely to include some form of financial assistance to households advocated by the ruling coalition. Nomura's latest economic forecast has assumed this. How will the tax reform plan for the 2026 fiscal year by the ruling coalition be? The ruling coalition usually announces its tax reform plan for the next fiscal year in mid-December. Global investors will pay attention to whether it includes some form of consumption tax reduction for the 2026 fiscal year. If the ruling coalition maintains the LDP/Komeito two-party structure, Nomura predicts that there will be no significant reduction in the consumption tax; however, if the coalition expands by absorbing one or more opposition parties, the possibility of tax cuts will slightly increase. If the 2026 fiscal year tax reform plan includes a consumption tax cut, what will be the scope/term? If only the food consumption tax rate is reduced from the current 8% to 0% and maintained for a year, while expanding the scope beyond food, Nomura believes this will trigger expansionary fiscal policy and reactions in the market through a significant increase in long-term and ultra-long-term interest rates and the weakening of the yen. Nomura estimates that reducing the food consumption tax rate from 8% to 0% will result in a decrease of approximately 1.5 percentage points in the CPI. Assuming no change in nominal income, this would correspond to an increase of about 1.5% in real income. Taking into account the impact on actual household consumption, Nomura expects a year-on-year increase of about 1.3% in total household actual consumption (approximately 3.9 trillion yen annually). Apart from the direct benefits category of food (due to the tax rate reduction), Nomura also expects increases in expenditures on housing, clothing and shoes, lighting/heating/water, etc. When evaluating the impact on real GDP, the chain of imports should also be considered, as an increase in domestic demand (consumption, investment, etc.) usually leads to an increase in imports. Assuming an import penetration rate of 16.5% in 2024, the 3.9 trillion yen increase in consumption will result in a corresponding increase in imports. Deducting the increased imports, the net contribution of household consumption to GDP would be approximately 3.3 trillion yen. Based on this calculation, real GDP would increase by about 0.6% on an annualized basis. It should be noted that Nomura's economic forecasts do not include a consumption tax reduction. If the progression based on the seven steps proposed by Nomura leads to a more expansionary fiscal policy (such as a consumption tax reduction), the probability of such expansionary policies occurring marginally may increase, especially in the case of the second step (expanding the ruling coalition, incorporating opposition parties). How will the global interest rate/foreign exchange markets react to the above six steps? If market concerns about a significant and sustained consumption tax reduction and doubts about the sustainability of Japan's government finances increase, the progress of the above six core steps at some point may trigger reactions in the interest rate market and a significant weakening of the yen in the foreign exchange market.