Japan’s New US Trade Deal and the Country’s Revolving Door

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Japan’s ruling coalition suffered its second defeat in nine months Sunday, losing its upper-house majority in parliament. Given this is the party’s second national electoral flop in less than a year, Prime Minister (PM) Shigeru Ishiba appears to be on shaky ground, with murmurs he will resign once the new US trade deal, announced Wednesday, is final. While this raises political uncertainty in the near term, the upshot is gridlock likely remains beyond this short-term drama, which isn’t a negative for Japanese stocks.

Ishiba’s Liberal Democratic Party (LDP) and its longtime coalition partner, Komeito, lost 19 of 66 seats up for grabs in Sunday’s election. The duo needed to win 50 (on top of their existing 75) to retain an upper house majority, but opposition parties gobbled them up instead, winning two-thirds of those available.^[i] While the traditional opposition, the Constitutional Democratic Party of Japan (CDPJ) took 22 seats, upstart parties made the biggest gains. This includes the populist Sanseito party, led by Sohei Kamiya, whose agenda echoes President Trump’s and the UK’s new Reform Party. Interestingly, this cuts against the broad pro-incumbency swing seen in non-US election results earlier this year—itself an about-face from earlier polling. As markets and developed economies navigate Trump’s tariffs better than many feared, is the sentiment pendulum now swinging back to anti-incumbency? Time will tell.

It could also just be a uniquely Japanese phenomenon. According to exit polls, voters grew frustrated with Ishiba and the LDP for several reasons—chief among them were slowing wage growth, high rice prices, the US tariff threat and a perceived lack of support for Japan’s aging population. Voters’ frustration precedes tariffs, too. The coalition, in power since 2012, lost its majority in the more powerful and influential lower house back in October.

For now, it appears the LDP and Komeito will retain power, heading a minority government. While the CDPJ has talked of forming alliances with smaller parties, they seem too fragmented to coalesce. But Ishiba’s days in charge look numbered.

He initially rejected rumors that he would exit, but in retrospect, this looks mostly like a play to ensure continuity as US trade talks progressed. The Yomiuri Shimbun reports that, amid rumors of party plans to oust him, he privately told LDP bigwigs Tuesday evening that, when the trade deal was done, he was too. In a press conference Wednesday, he said “I will make a final decision [on whether to step down] based on the results of the tariff negotiations.”^[ii]

Hours later, the Trump administration unveiled its trade deal with Japan. This might seem like a big policy win potentially shoring up Ishiba’s position, but it is perhaps a teensy bit complicated. The deal secures a 15% tariff as opposed to the threatened 25%—and extends that reduction to autos, in a positive surprise. The powerful Japan Business Federation welcomed the lower-than-feared levies, but it also noted this is substantially higher than tariffs were.^[iii] Economic sentiment in Japan is already quite low due to tariff fears. But we doubt the deal does much to improve the Ishiba cabinet’s rock-bottom approval rating, which currently sits at a record-low 23%, especially given business lobbies’ reaction.^[iv]

We suspect that, by letting Ishiba complete the deal and then bow out gracefully, the LDP hopes to draw a line under the past nine months and start fresh with a new leader. This would give a new PM three years to rebuild the party’s popularity before the next general election in October 2028, barring a snap election (always a wildcard).

Who might that fresh face be? Political observers have flagged some contenders. One is Shinjiro Koizumi, the longtime presumptive LDP heir apparent as the son of wildly popular PM Junichiro Koizumi, in office from 2001 – 2006. After rising rapidly through the party ranks, he hit a snag a few years ago and became a bit of a meme. But he has returned to the cabinet, currently serving as Agriculture Minister. This put him in voters’ crosshairs, given his main brief was taming rice prices. Will his efforts to do so win enough favor and respect? We will see.

House member Sanae Takaichi is also garnering attention. The former heavy metal band drummer performed well in 2024’s leadership contest before eventually losing to Ishiba and was a close ally of late former PM Shinzo Abe. She casts herself as the candidate to advance his economic policies, which could curry some favor.

Finally, some coverage suggests Chief Cabinet Secretary Yoshimasa Hayashi could fill the void. He is the classic “safe pair of hands,” given his history of stepping into other cabinet roles during reshuffles.

Inevitably, leadership contests put the focus on personality and sociology—two things markets don’t weight heavily. They chiefly evaluate a government’s ability to legislate—and how the size and scope of legislation squares with broad expectations. In competitive developed nations, gridlock is usually optimal, reducing the risk of sweeping change. Such legislation, whatever you think of it, creates winners and losers, discourages risk-taking and can hamper investment plans. Gridlock is the antidote.

Japan has historically been a bit of an exception, given a long-running need for structural reform to modernize its economy and address its rigid labor market. But the elder Koizumi and Abe plucked about as much of the lowest-hanging fruit as possible, and Japan has made great competitiveness strides. There are still opportunities for reform, but overcoming the entrenched interests blocking change would require significant political capital. No one on the scene seems to have that. Therefore, in Japan’s case, gridlock should be fine, curbing the risk of policies undoing some of the beneficial changes or seeding other unintended consequences.

Hence, Japanese stocks probably won’t mind Japan’s infamous “revolving door” of prime ministers taking another turn. Between Koizumi’s resignation in 2006 and Abe’s second term starting in 2012, Japan went through six prime ministers in six years. Fast forward to today, and Ishiba would be the third since Abe stepped down in September 2020.

All this is a recipe for gridlock. The new leader has to rebuild the party’s clout and develop some personal staying power ahead of the next vote. A minority government trying to mend fences strikes us as extra gridlocky.

In our view, this is all fine for stocks. Yes, Japanese stocks fell during the first “revolving door” period, which included 2008’s global financial crisis and its aftermath, in which Japanese stocks struggled amid the 2011 Fukushima disaster. The second “revolving door” period has been a much different story. Since Abe resigned in September 2020, Japanese stocks are up 105.6% and hit all-time highs in 2024, finally regaining ground unseen since the late 1980s’ Nikkei bubble burst.^[v]

To us, the stark difference here suggests Japanese stocks have grown accustomed to the constant in-and-out at the Kantei. Political uncertainty hasn’t stopped them in their tracks, or even really changed the overall picture. With another shakeup looking likely, we doubt this changes.