USD/JPY should keep heading south into the Liberal Democratic Party (LDP) leadership election on October 4. Recent polls suggested that Shinjiro Koizumi has gained momentum against Sanae Takaichi. Markets consider a Koizumi win as JPY-positive because he is seen as more pragmatic on fiscal policy and supportive of closer coordination with the Bank of Japan in normalizing monetary policy. By contrast, Takaichi is associated with an expansionary growth agenda fuelled by more aggressive fiscal spending and resistance to rate hikes.
On October 4, the candidate who secures a simple majority out of the total 590 votes wins. If not, the top two vote-getters will proceed to a run-off, which will give more power to lawmakers (where Koizumi has a lead here) – LDP Diet members account for 295 out of the 342 votes in the second round. Next, the LDP will convene an extraordinary Diet session on October 15 to elect the new prime minister.
Additionally, we expect the JPY to find support in Fed-BOJ monetary policy divergences at the end of October. Following the shocking 32k decline in US ADP employment in September and a revision to -3k from 54k in August, the futures market has priced in a more than 100% chance for a 25-bps cut at the FOMC meeting on October 29. Over the past week, the JPY’s recovery was also underpinned by market pricing for a more than 50% chance of a BOJ hike on October 30. At its September meeting, the BOJ kept rates steady, but two of the nine board members dissented and called for a 25-bps hike. This first dissent under BOJ Governor Kazuo Ueda was viewed as a coordinated signal that a hike is approaching. Ueda’s speech on October 3 should provide further insight into the BOJ’s thinking. 
Against this background, the JPY has regained its haven status from rotation plays amid disappointing performances in traditional havens, such as the CHF and SGD. A Koizumi win could extend the JPY’s rally by maintaining expectations for a BOJ hike amid uncertainties over how long the US government shutdown would last and hurt the US labour market. However, profit-taking could emerge after the Fed cut and the BOJ hike. Beyond unifying the LDP, Japan’s next leader faces a daunting set of challenges constrained by the LDP’s minority in both houses of parliament. Any inability to balance between voters’ demand for cost-of-living relief and the market’s expectation for fiscal discipline could translate into renewed JPY volatility.
Quote of the Day
“A photograph is usually looked at - seldom looked into.”
Ansel Adams
October 2 in history
In 2007, President Roh Moo-hyun of South Korea walked across the Military Demarcation Line into North Korea on his way to the second Inter-Korean Summit with North Korean leader Kim Jong Il.
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