Stock investors in Japan have already felt the sting of what’s being called the “Ishiba shock.” However, the turmoil shaking the markets may only just be beginning for currency traders. With the yen seemingly set to surge, the election of veteran lawmaker Shigeru Ishiba as Japan’s next prime minister could herald significant shifts for global financial markets.
Ishiba, who is 67 years old and a self-described “lone wolf” within Japan’s ruling Liberal Democratic Party (LDP), came out of nowhere last week to secure the leadership position, beating out eight other contenders. His election has left analysts scrambling to reassess Japan’s economic policies and the yen’s future trajectory.
While Ishiba has downplayed his well-known preferences for Bank of Japan (BOJ) rate hikes and a stronger yen, traders may be making a mistake in assuming that Ishiba won’t push for a more hawkish monetary policy.
At present, Ishiba is cautious, with his public comments not aligning entirely with his previous positions on monetary tightening. The yen has been on a downward trajectory this week, as traders anticipate that Ishiba might be more dovish than initially feared. However, this may only be a temporary reprieve.
Behind the scenes, it seems likely that Ishiba has been advised to tread carefully. Even BOJ Governor Kazuo Ueda, typically a monetary hawk, has been cautious about further tightening given Japan’s fragile economic recovery and the growing uncertainties stemming from China’s economic slowdown. Ishiba’s economic advisors are likely considering the same factors. After all, the Japanese economy is at a critical juncture, and premature rate hikes could derail its recovery.
Nevertheless, Ishiba’s long-standing inclination toward higher interest rates and a stronger yen will be difficult to suppress for long. Since July 31, when the BOJ raised short-term interest rates to their highest levels since 2008, the yen has steadily recovered, erasing much of its sharp losses earlier in 2024. The yen, which hit a historic low of 161 to the US dollar in late June, has since rallied more than 9%, trading around 147 yen to the dollar by early October.
With Ishiba’s ascension to power, many experts believe that the yen could strengthen even further. Some are even speculating about a potential return to levels as high as 125 yen to the dollar, raising concerns of a future “Ishiba shock” that could reverberate through global markets.
Japan’s Economic
Before any radical changes can take place, Ishiba and the LDP must first secure victory in the upcoming snap election on September 27. Given the disarray within Japan’s opposition parties, the odds are in Ishiba’s favor.
Once he assumes office, the BOJ may find a strong ally in Ishiba, particularly in his desire to move Japan away from its ultra-low interest rate policies. Ishiba has made no secret of his belief that the persistently weak yen has done more harm than good. In an interview with Reuters as recently as August, Ishiba stated that the BOJ is “on the right policy track to gradually align with a world with positive interest rates.” His comments suggest that he is ready to support the BOJ as it moves toward abandoning the near-zero interest rate environment that has characterized Japanese monetary policy for more than two decades.
Ishiba has also argued that while stock markets may react negatively to rate hikes, the broader benefits of stronger interest rates cannot be ignored. He points out that higher rates could help reduce the cost of imports, especially for energy and raw materials, which would ultimately make Japanese industries more competitive.
These views clash sharply with those of Sanae Takaichi, one of Ishiba’s main competitors in the LDP race and a staunch advocate of the economic stimulus policies championed by former Prime Minister Shinzo Abe. Takaichi has been vocal in her opposition to raising interest rates, stating that it would be “stupid” to do so during a period of cost-push inflation.
“Ishiba’s take is that a quarter-century of free money has dulled the sense of urgency for reforms that could modernize Japan’s economy,” says economic analyst Yuki Takashima. These include structural reforms to labor markets, reducing red tape, fostering innovation in startups, and empowering Japan’s shrinking workforce, particularly women. The ultra-low rates, Ishiba contends, have also allowed corporate Japan to avoid taking bold steps to restructure, innovate, and compete globally.
Japan’s experiment with quantitative easing (QE) has had far-reaching consequences. Since the policy began in 2013 under Abe’s “Abenomics,” the BOJ has accumulated such a massive hoard of government bonds and stocks that by 2018, its balance sheet surpassed Japan’s annual GDP of $4.7 trillion.
This unprecedented intervention has left the BOJ in a precarious position, with little room to maneuver. Any move to exit these policies without triggering market volatility will be a monumental challenge. The violent sell-off in global markets following the BOJ’s tightening on July 31 has only added to the central bank’s hesitation. But with inflation heating up, the pressure to act may become overwhelming.
Analysts like Takeshi Yamaguchi, an economist at Morgan Stanley MUFG, point to growing wage pressures as a significant factor driving inflation. Earlier this year, Japanese labor unions won the largest pay raises in more than three decades, part of a long-standing effort to create a “virtuous cycle” in which higher wages boost consumption and GDP. However, without matching productivity gains, these wage hikes could accelerate inflation, forcing the BOJ’s hand once again.
Japan’s “core” consumer price index, which excludes volatile food prices, rose 2.8% year-over-year in August, marking the fourth consecutive month of acceleration. With inflation running above Tokyo’s 2% target, there are growing calls for the BOJ to implement another rate hike at its October meeting.
If Ishiba supports this move, it could signal the beginning of a broader shift in Japan’s monetary policy, potentially putting an end to more than two decades of zero-interest rate policies.
Yen and Global Perceptions
A key reason for Ishiba’s resistance to a weak yen is his belief that it undermines confidence both within Japan and internationally. The weak yen reduces households’ purchasing power and leaves Japan vulnerable to imported inflation, particularly from rising commodity prices. This vulnerability is compounded by Japan’s heavy reliance on energy imports.
For foreign investors, Japan’s adherence to what some see as a developing-nation-like currency policy has been perplexing. As one of the world’s largest economies, Japan’s refusal to wean itself off ultra-low interest rates and a weak currency has created skepticism about the country’s long-term growth prospects. Many investors remain wary of the “Japan is back” narrative that has gained traction in recent years.
However, there is also a sense that political forces may attempt to temper Ishiba’s hawkish tendencies. Some LDP insiders have already indicated that Ishiba may be more restrained in his monetary policy views than expected. “His stance on monetary policy is thought to be the same as the Kishida administration, which respects the independence of the BOJ,” says Masafumi Yamamoto, a strategist at Mizuho Securities.
Moreover, analysts at UBS believe that Ishiba’s recent comments signal a desire to maintain a more accommodative monetary stance, at least in the near term. They argue that the yen’s appreciation will likely be gradual rather than rapid.
Currency Markets
Despite these reassurances, the global financial community remains on edge. Traders and speculators are betting heavily on a stronger yen, and data from the US Commodity Futures Trading Commission (CFTC) shows that hedge funds hold more than 66,000 positions betting on a rising yen, the largest such position since 2016.
These positions are partly the result of the “yen-carry trade,” where investors borrow cheaply in yen and reinvest the funds in higher-yielding assets around the world. With the BOJ keeping rates at or near zero for the better part of two decades, the yen-carry trade has ballooned to an estimated $4.4 trillion. This sum, larger than the entire Indian economy, underscores the potential for massive disruptions should the yen begin to strengthen dramatically.
A sharp rise in the yen could upend this trade, sending shockwaves through global markets. While some argue that Ishiba’s rise will lead to only a gradual appreciation of the yen, others warn that a move toward 125 yen to the dollar is far from out of the question.
For now, markets are holding their breath, waiting to see how Ishiba will navigate the complex economic landscape before him. But with inflationary pressures building, wage growth accelerating, and the BOJ facing mounting pressure to normalize monetary policy, the “Ishiba shock” could be far from over.
Should the yen-carry trade unravel, it would not be a “black swan” event—an unforeseen market catastrophe—but more of a “gray swan,” a predictable yet disruptive force in global finance. For currency traders, the next few months may prove decisive in determining whether the yen’s rally will be slow and steady or a sudden jolt that shakes global markets to their core.
