A Trader’s Guide to Japan’s Ruling Party Leadership Election

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(Bloomberg) — As Japan’s ruling party prepares to vote on a new leader who could become the country’s next prime minister, traders are bracing for a possible impact on the yen and shares of exporters, banks and energy companies.

The impact of monetary policy is an important point to watch, as the exit of Prime Minister Fumio Kishida is seen as paving the way for the Bank of Japan to continue tightening. Although the central bank is independent from the government, it is always under political pressure.

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“Regardless of who wins, I think the BOJ will have to get used to politicians who talk a lot to try to influence the central bank,” said Phillip Wool, head of portfolio management at Rayliant Global Advisors. “That will be frustrating, but it’s true now that inflation policy and the BOJ are very much front and center on voters’ minds.”

The Liberal Democratic Party leadership election scheduled for Friday features a record nine candidates, although the focus is on the top three. Long-serving LDP politician Shigeru Ishiba and junior Shinjiro Koizumi are both seen as conservative on fiscal policy. Sanae Takaichi, if elected, would be Japan’s first female prime minister, and wants to keep interest rates low.

The government’s comments on BOJ policy could shake the yen, which started to strengthen after touching its weakest level since 1986 earlier this year. Beyond the forex effect on exporters, the LDP leadership race is impacting stocks in sectors ranging from defense to human resources.

Here’s an in-depth look at some of the key things investors will be watching for in the election:

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Shigeru Ishiba

Ishiba appears to support the central bank’s plan to continue to strengthen gradually as a way to strengthen the yen. Traders fear that this could dampen the broader rally that has spurred equities to record highs on the perceived profits of companies that sell products overseas.

With Ishiba and fellow veterans Taro Kono and Toshimitsu Motegi, “there is a risk that these candidates are too hawkish, which could be a headwind for stocks and could lead to more volatility in the yen,” Rayliant’s Wool said.

Investors also expressed concern over Ishiba’s decision to raise tax on financial income.

One sector that could benefit if Ishiba takes over and the BOJ raises rates is the bank. The Topix Banks Index has been outperforming expectations of a tightening, although its gap with the broader gauge has narrowed.

Shinjiro Koizumi

The youngest contestant at 43 years old, Koizumi enjoys popularity among his fellow lawmakers. If elected, the son of former Prime Minister Junichiro Koizumi is expected to continue largely on Kishida’s policy trail and support raising interest rates.

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Koizumi is likely to be “more neutral on the markets,” and the initial results are likely to be a “bearish reduction in bonds,” with gains in stocks and a strong yen, Naka Matsuzawa, strategist at Nomura Securities Co, wrote in a note.

Among other issues, Koizumi said he would review restrictions on the dismissal of workers, which would lead to more movement in the labor market and benefit companies such as Recruit Holdings Co. and Dip Corp.

The former environment minister is also known as an advocate for fighting climate change, which could have a positive impact on companies from green technology provider Hitachi Ltd. to solar company Renova Inc. And fully support ride sharing.

Sanae Takaichi

Takaichi, who could become Japan’s first female leader, has been a staunch supporter of easy monetary policy, saying earlier this week that it was “foolish to raise rates now.” His support for former Prime Minister Shinzo Abe’s reflationist policy platform is a major distinguishing factor in his candidacy.

Any delay in the BOJ’s interest rate hike could keep the Japanese currency weak. That could have continued benefits for shares of electronics exporters and automakers. It could also provide the windfalls of a wave of inbound tourism that has benefited department store operators such as Isetan Mitsukoshi Holdings Ltd.

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“If he wins the LDP presidential election, the initial market reaction will be a weaker yen, lower interest rates and higher stock prices,” said Naomi Muguruma, fixed income strategist at Mitsubishi UFJ MS Securities Co. “It makes sense. that monetary policy will be expanded and fiscal cuts will be extended.”

Other Problems

One thing on which most of the candidates are united is to support the restart of nuclear power plants. Utilities such as Tokyo Electric Power Co. they will be among the biggest beneficiaries as the low-cost fuel meets high demand as Japan aims to strengthen its presence in the power-hungry semiconductor ecosystem.

Most also favor a larger global military role for Japan, as the country’s Defense Ministry has already requested a record budget for the fiscal year that begins in April. Defense stocks like Mitsubishi Heavy Industries Ltd. and Kawasaki Heavy Industries Ltd. are among the top gainers this year on the Nikkei 225 Stock Average.

—Courtesy of Masahiro Hidaka and Daisuke Sakai.

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