Fukuda - Gone with the winds

I was caught off-guard when PM Fukuda announced his intention to resign. In my previous posting (28 August 2008), I highlighted that it would be a tough time for Fukuda ahead, but I never expect such shock could come in such timing considering that it was just a month after the Cabinet shuffle.

The Fukuda's discord with the New Komeito Party, whose support is vital for the LDP had recently grown sharper and the amount of politicking in terms of new appointment is tremendously challenging.

Fukuda's speech in his inauguration as Prime Minister remained very fresh in my memory that 'I take this office knowing of the difficulties that lie ahead' and 'This Cabinet will fight with its back to the wall'.

Following the news, I expect a weaker JPY, stocks and JGBs to rise on the weakness of equity market, pretty similar to the last year's dramatic resignation of PM Abe. However, this time around, I foresee that the impact is likely to be range bound. So far neither Nikkei futures nor FX market are showing any reaction. The question is whether this will mark the dismantling of the coalition and possibly the end of the LDP - in a sense the completion of a process started in 1993 when the LDP were voted out but clawed their way back in. Perhaps, markets are already getting used to political dynamics in Japan. More likely is that we could see thin trading to continue as Japan's political situation has become "another factor of uncertainty" on top of the existing woes the market faces such as a bleak global economic outlook and credit worries.

Assuming that LDP Secretary General Taro Aso becomes Prime Minister, I see a good potential for a rebound in JPY assets, riding on his popularity and as his policy focus will shift towards more fiscal expansion from fiscal retrenchment. Aso would likely prioritize stimulating the struggling Japanese economy ahead of cutting down the government's huge debt, perhaps abandoning a goal of a balanced budget within the next few years. If the likelihood of more JGB issuance becomes a much more likely scenario, longer-term yields in Japan could move higher.

Short term, Aso premiership might therefore lift consumer confidence a little and help to ease policy gridlock. With Fukuda increasingly seen as a lame duck, the markets will probably regard any change of leadership as a 'good thing'.