Between U.S. Tightening Scenarios and Japan’s Expanding Deficit Post-Elections

Rania Gule

The USD/JPY pair is rising, driven by renewed momentum supported by the ongoing divergence in monetary policies between the Federal Reserve and the Bank of Japan. Yield differentials between the two economies remain a key factor in explaining the pair’s price action. The dollar gained additional support following the release of U.S. retail sales data, which significantly exceeded expectations, thereby weakening the likelihood of a Fed rate cut in September and prompting traders to reprice risk accordingly. A 0.6% rise in sales compared to a 0.1% forecast reflects continued strength in consumer demand, reinforcing the Fed’s relatively hawkish stance that sees little urgency to ease policy amid persistent price pressures.

In this context, I view the dollar’s rise against the yen as a natural reflection of both macroeconomic and technical factors, especially as the pair approaches the psychological resistance level of 149.15. If U.S. data continues to outperform and Japanese fundamentals remain stagnant, this level could be breached. In my view, holding above 148.80 will encourage traders to test higher technical levels near 149.30 and eventually 150.00, particularly if more hawkish remarks emerge from Fed officials in the coming days. On the Japanese side, the BoJ’s persistent commitment to low interest rates creates a fertile ground for further yen weakness — a policy stance that seems to be part of an implicit strategy to stoke inflation through currency depreciation.

However, price action doesn’t unfold in a vacuum. Japan’s political and fiscal backdrop is casting a heavy shadow on investor sentiment, especially with the upcoming Upper House elections this Sunday. At this critical juncture, Japanese bond yields have spiked sharply, reflecting growing expectations of unchecked fiscal expansion following the elections. In my view, this surge in yields isn’t merely a technical move; it signals deeper market anxiety about the incoming government’s ability to balance economic support with fiscal restraint. I expect yields to continue rising through the third quarter, potentially surpassing 1.2% unless the government outlines a credible financial roadmap that reassures markets.

These concerns are further complicated by Japan’s debt-driven fiscal model. As one of the most indebted countries relative to GDP, Japan relies heavily on issuing new debt to meet its obligations. In my opinion, this model is no longer sustainable. Without a clear structural fiscal reform plan within the next two years, sovereign credit ratings could come under increasing pressure, pushing Japan toward harsh policy divisions or even disruptions in its bond market. This current model resembles walking a tightrope; even a minor loss of confidence or revenue shock could destabilise its financial equilibrium.

Amid these pressures, a controversial policy proposal has emerged: cutting the consumption tax. I view this move as a financial misstep at this time. While it may offer short-term electoral appeal, it jeopardises medium-term fiscal stability, particularly if not paired with alternative revenue sources. In my estimate, reducing the tax from 10% to 8% without offsetting measures could widen the fiscal deficit by ¥7 to ¥10 trillion annually, translating into pressure on both the yen and bond yields. In short, markets are unlikely to tolerate such populist measures and will likely react swiftly and harshly.

In an attempt to calm market nerves, Prime Minister Shigeru Ishiba stated he would not finance any tax cuts through additional borrowing. While this message offers some reassurance to the markets, it lacks an actionable plan. Without accompanying implementation details, the impact of this statement is muted, keeping markets in a state of cautious anticipation. In my view, this position may temporarily slow the rise in yields, but it is insufficient to shift the broader trajectory unless backed by clear strategies on both spending and revenue fronts.

What is more concerning is that markets have already begun pricing in a potential post-election collapse in the Japanese bond market — a reflection of fragile investor confidence. While I do not foresee a full-scale crash, I do anticipate a sharp correction of 5% to 10% in bond prices within two weeks following the elections, especially if the new government’s messaging is both expansionary and vague. Such a correction would likely force the BoJ to intervene again and potentially reassess its quantitative easing programs, which in turn could spark heightened volatility in currency and yield markets.

On a broader scale, eroding confidence in Japanese bonds poses a serious risk to global debt markets, given the size and international significance of Japan’s government bond market. Should international investors begin to question the sustainability of Japan’s fiscal path, it could trigger a global yield surge, especially in high-debt countries like Italy and France. The ripple effects may also extend to emerging markets, where we could witness capital flight and rising borrowing costs that threaten macroeconomic stability.

In my view, the USD/JPY pair is not simply reacting to short-term data or technical indicators — it is a mirror reflecting a broader conflict between an economy that has successfully delayed slowdown (the U.S.) and another that is masking structural fragility behind ultra-low interest rates (Japan). As long as this divergence persists, the most likely scenario is continued upside for the pair, though at a measured pace, and closely tied to how the political and fiscal narrative evolves in Tokyo over the coming weeks.

Technical Analysis of ( USDJPY ) Prices:

The USD/JPY pair is currently trading near a critical technical zone around the psychological resistance level of 149.15, where several technical factors converge to heighten the sensitivity of this area. Most notably, it aligns with the 50% Fibonacci retracement level of the decline from the January high to the April low, adding further significance to this resistance. A bullish breakout above this level — particularly if accompanied by strong momentum and high trading volume — could trigger a fresh wave of buying targeting the 150.00 level, which has historically acted as a battleground between bulls and bears, making it a key short-term resistance.