On October 27 local time, Japan held a parliamentary lower house election. Voting took place from 7:00 to 20:00 local time (excluding some areas). Analysts warn that due to the influence of the 'political dark money' scandal, Japan's ruling party, the Liberal Democratic Party (LDP), and its governing ally Komeito are facing their biggest governance crisis since 2009.

Analysts believe that if the LDP's strength is significantly weakened after the election, the effective governance ability of Japan's Prime Minister Shizo Abe may be affected, and the election results may even have far-reaching implications for the future of the country's financial industry.

The latest opinion polls show that the LDP may lose its current majority seats for the first time since 2009. Barclays points out that if the election results are even worse, and the LDP-Komeito coalition loses too many seats to form a government, the Nikkei 225 Index may plummet by 5%.

Is Japan facing a black swan event?

On October 27 local time, Japan held a parliamentary lower house election. Voting took place from 7:00 to 20:00 local time, except in some areas.

The Japanese House of Representatives has a total of 465 seats, and elections are held every 4 years. The elections follow a mixed-member majoritarian system, with voters directly voting for candidates in single-seat constituencies with the highest vote-getter winning; while proportional representation seats are allocated to parties based on the votes received. On October 9, Japanese Prime Minister Shinzo Abe dissolved the lower house after only 8 days in office, calling for early elections.

Analysts warn that due to the impact of the 'political dark money' scandal, support for Japan's ruling party, the Liberal Democratic Party (LDP), has been steadily declining, and it is expected that this election will present the party with its most serious electoral challenge in over a decade.

According to a public opinion survey, the Liberal Democratic Party may lose its current absolute majority for the first time since 2009.

Barclays stated in its latest research report that Japan's ruling party, the Liberal Democratic Party, and its governing ally, Komeito, are facing their largest governance crisis since 2009.

Barclays believes that if the coalition of the Liberal Democratic Party and Komeito loses its majority but can still form a government, the Bank of Japan is expected to maintain a dovish stance, potentially curbing interest rate hikes, leading to further depreciation of the yen; however, if the alliance loses too many seats and is unable to form a government, it is expected that the yen will appreciate significantly, long-term bond yields will decrease, and Japanese stocks will decline.

Barclays predicts that in the second scenario, the USD/JPY exchange rate could drop by 2%, the 10-year Japanese government bond yield will decrease by 7 basis points, and the Nikkei 225 index may even plummet by 5%.

Before the election, the LDP and Komeito hold 256 and 32 seats in the House of Representatives respectively, totaling 288 seats.

The goal of the coalition between the Liberal Democratic Party and Komeito is to maintain an 'absolute stable majority', occupying at least 261 out of 465 seats in the House of Representatives. This number of seats not only ensures smooth legislative progress, but also guarantees the ruling coalition's influence in various committees.

However, Barclays' report points out that the LDP and Komeito may struggle to even secure the goal of a stable majority of 244 seats. Based on the latest opinion polls, the market is starting to worry that a coalition government may not even be able to meet the threshold of a simple majority of 233 seats.

According to the latest surveys by Asahi Shimbun and Mainichi Shimbun, even in the best-case scenario, the likelihood of the LDP independently securing a majority of seats remains low.

A recent public opinion poll by the Japanese newspaper Asahi Shimbun shows that the Liberal Democratic Party (LDP) may encounter difficulties in the election, potentially losing up to 50 of its current parliamentary seats, while the Komeito party's seats may fall to below 30.

According to a survey by Asahi Shimbun, Japan's largest opposition party, the Constitutional Democratic Party (CDP), could potentially gain as many as 140 seats in the election, exceeding the current 98 seats.

Rob Fahey of the Tokyo Waseda Advanced Research Institute stated that the election results in Japan may be announced on Sunday evening, with only some seats (those requiring recounts or other issues) to be announced on Monday.

"Possible 5% plunge"

If the ruling coalition loses its majority, the Liberal Democratic Party may need to form alliances with more smaller parties, potentially making it harder for the current Prime Minister Shizo Abe to push for fiscal austerity and normalization of monetary policy, putting his premiership at risk.

Naoki Matsuzawa, chief macro strategist at Nomura Securities, warned that this is essentially a "sell Japan" situation, as investors are contemplating how the election results will impact fiscal and monetary policies. The Japanese stock market has already experienced a wave of pullback this week, with the Nikkei 225 index falling by 2.74%.

Analysts believe that although other parties are unlikely to overturn the Liberal Democratic Party at this point, if the party's strength significantly weakens after the election, Shizo Abe's effective governance could be affected. As Japan navigates through this period of economic and political uncertainty, the election results will have a profound impact on the country's financial future.

Barclays points out that in this highly uncertain political situation, the Japanese stock market is facing triple pressure - domestic elections, US elections, and corporate financial reports.

Reviewing historical data since the 1970s, when the ruling party in Japan barely maintains a majority, the Japanese stock market often experiences sustained negative impacts, but when the situation becomes clear, the stock market quickly recovers.

Barclays pointed out that if the worst 'tail risk' scenario occurs, where the Liberal Democratic Party and Komeito lose enough seats to form a government, the Japanese stock market may exhibit classic risk aversion sentiment.

Barclays expects that in this scenario, the US dollar against the Japanese yen may fall by 2%, the 10-year Japanese government bond yield will decrease by 7 basis points, and the Nikkei index may plummet by 5%.

Additionally, JPMorgan strategist Rie Nishihara also believes that the Japanese stock market is considering the situation where the ruling coalition could lose the majority of seats. History shows that unless the Liberal Democratic Party alone wins 60% of the seats, the Japanese stock market will decline.

Neil Newman, Strategic Director of Astris Advisory Japan, stated that although the Liberal Democratic Party is expected to face setbacks, the likelihood of a government change is slim, meaning any negative impact on the stock market may be temporary.

Newman added that many investors will be closely watching the outcome of the Bank of Japan's monetary policy meeting next week. The Bank of Japan's rate hike policy is largely set, but the pace at which they implement the rate hike policy may depend on the government's situation after the election.

It is worth noting that the Constitutional Democratic Party proposed lowering the Bank of Japan's inflation target to 'above 0%', which the market interpreted as a 'hawkish' signal that could lead to significant interest rate hikes and a stronger yen.

Editor/ping