Japan's Nikkei seen hitting new highs as yen, bonds sputter on Takaichi victory

Japanese shares are expected to keep setting records even as the nation's currency and bonds sputter after fiscal dove Sanae Takaichi was elected on Saturday to lead the ruling party and likely become prime minister.

Takaichi, 64, was considered to have the most expansionist fiscal and monetary agenda among five candidates in the Liberal Democratic Party race to replace hawkish Prime Minister Shigeru Ishiba. In the lead-up to the LDP race, a "Takaichi trade" emerged - long on stocks and bearish on Japanese government bonds, particularly longer maturities - positioning for a win by Takaichi, a devotee of the "Abenomics" stimulus policies of the late Shinzo Abe.

'POSITIVE SURPRISE' FOR SHARES, BONDS ON EDGE Japan's benchmark Nikkei logged a record closing high of 45,769.50 on Friday, topping the record set the week before, as investors bet whoever succeeded Ishiba would be more dovish.

Short positions on the gauge have been building up recently and may now be unwound, said Resona Holdings strategist Hiroki Takei. "This could be considered a positive surprise for stock prices," Takei said. "If short-covering is triggered, the rally could gain momentum, potentially pushing the index toward the 47,000 level."

The Japanese government bond market has been on edge since late May due to waning demand among traditional buyers, decreased support from the central bank and concerns about swelling debt. The sector was dealt another blow in July, when Ishiba's coalition lost its majority in the upper house of parliament - having lost its lower house majority last year - as outsider parties campaigning on tax cuts and increased spending gained seats.

The 30-year JGB yield surged to a record 3.285% on September 8, the first trading day after Ishiba announced he was stepping down. In recent weeks, the Nikkei's momentum slowed and longer-term JGBs rallied as markets gave the edge in the LDP race to farm minister Shinjiro Koizumi and Takaichi appeared to moderate her stance, leaving sales tax cuts out of her platform and staying mostly mum on the Bank of Japan.

"She seemed to have toned down her rhetoric recently but ultimately the feeling is still that she will push for looser fiscal and monetary policy," said James Athey, a fixed income manager at British investment group Marlborough. "As such, there is likely to be a negative reaction in long-end JGBs and the yen." Japan's currency closed at 147.44 per dollar on Friday, staging a 1.4% gain on the week that was the sharpest since mid-May.

After her LDP victory, Takaichi told a press conference the government and central bank must work closely to ensure Japan's economy achieves demand-driven inflation backed by rising wages and corporate profits. Prices for shorter-dated JGBs, those most sensitive to central bank rates, have been on a declining trend, pushing their yields higher as evidence mounted that Japan's economy was sound enough for the BOJ to resume tightening policy.

BOJ Governor Kazuo Ueda has put the central bank on a long-term path to raise interest rates and shrink its balance sheet after more than a decade of massive stimulus that was a key part of former Prime Minister Abe's economic platform. Yields on two-, five-, and 10-year JGBs have all reached levels not seen since the financial crisis in 2008 on bets the BOJ could raise rates as early as this month's meeting.

Takaichi's wide support among rank-and-file LDP members will lend her cabinet a strong mandate and a heavy hand in influencing monetary policy by the BOJ, said Tohru Sasaki, chief strategist at Fukuoka Financial Group and a former BOJ official. "Takaichi will make it difficult for the BOJ to raise rates, so yields will go lower," Sasaki said. "But at the same time, she's likely to expand spending, which is negative for bonds. A steepening of the yield curve is a possible reaction."

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