Market Extra: 3 things to know about Japan’s snap election

Japan is going to the polls on Oct. 22 to vote in an early election that Prime Minister Shinzo Abe put on the agenda last month. Though the result will likely give more power to the incumbent, there is a tail risk that could derail the yen.

Official campaigning kicked off on Tuesday, giving candidates just under two weeks to win over voters. Incumbent Prime Minister Abe appears to be in the lead, but a surprise result could upset markets.

See also: Is the fourth-quarter season for dollar strength?

Consolidating power

Abe is hoping to consolidate his position in Japan’s parliament, which his Liberal Democratic Party currently leads in coalition with the center-right Komeito party.

The prime minister’s approval ratings improved in the wake of escalating tensions with North Korea. Polls have shown a slight drop in his support, but still leave him in the lead.

This is comforting to investors, who have grown to know Abe and all his Abenomics stand for, such as monetary stimulus and a weak yen, over the past years.

“Recent media polls suggest a victory for the incumbent parties,” wrote Matteo Crimella, interest rate strategist at Goldman Sachs. Abe could become the country’s longest-serving prime minister.

Early indications were that Abe’s LDP might not clutch a victory so easily, Goldman currency strategists Zach Pandl and Kamakshya Trivedi wrote in a note last week.

“However, if the coalition wins a majority but the LDP is unable to secure it alone, the election result could result in Prime Minister Abe’s resignation in order to take responsibility within the LDP, depending on the number of seats lost […],” he added.

The new kids on the block

In the lead-up to the unscheduled vote, two new parties entered the Japanese political scene to face off with Abe’s Liberal Democratic Party. Tokyo Governor Yuriko Koike is running for her recently founded Party of Hope, pledging popular measures such freezing sales tax and phasing out nuclear power.

Even though details on the Party of Hope’s preferred monetary policy are hard to come by, the tone of its campaign could mean that its victory “would call into question the sustainability of the bank of Japan’s easy stance, and open the field of candidates for Governor Kuroda’s replacement,” Pandl and Trivedi said. Kuroda’s term ends in April. Over the weekend, Koike has lost some support, polls showed at the beginning of the week.

Meanwhile, Abe’s previously largest opposition—the Democratic Party—effectively disbanded in late September due to lack of support, but partially resurfaced as the newly formed Constitutional Democratic Party.

Potential trouble for the yen

The Japanese yen USDJPY, -0.16%  had a tumultuous September, as the dollar regained momentum and rallied 2.2% against its Japanese counterpart, even trading above ¥113 for the first time since July. On Tuesday, one dollar bought ¥112.22.

A surprise election outcome could lead to a renewed dollar-yen rally, as it could spell the end of Abenomics and a change of direction for the Bank of Japan.

“So even though some aspects of Hope’s agenda may be pro-growth, the bottom line for FX markets is that dollar-yen pair should tend to be negatively correlated with polling results for Hope, at least until the party’s views on monetary policy become clearer,” Pandl and Trivedi said.

Japanese 10-year government bonds TMBMKJP-10Y, +0.44%  last yielded 0.05%, up almost 20% from Monday. Over the past month, then 10-year’s yield has hovered around 0%, with a low of -0.02% and a high of 0.07%.

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