The election of Shigeru Ishiba as Japan’s next leader was expected to roil the stock market

Unlock Editor’s Digest for free

FT editor Roula Khalaf selects her favorite stories in this weekly newsletter.

The election of Shigeru Ishiba as leader of Japan’s ruling Liberal Democratic Party will weigh on the country’s stocks on Monday morning, after Nikkei 225 futures fell 6 percent following his victory this week.

Ishiba, a former defense and agriculture minister who is set to take over as prime minister on October 1, is a China hawk who has vowed to prevent the nation from slipping back into deflation.

The new LDP leader has said he supports the Bank of Japan’s plan to normalize monetary policy, but investors are concerned about his support for higher corporate taxes and investment income.

Before the winner of the leadership race was announced on Friday, Japan’s Nikkei 225 index rose 2.3 percent and the yen fell, suggesting the market was poised for a victory by Economic Security Minister Sanae Takaichi. Takaichi championed the stock market-friendly “Abenomics” policies of ultra-low interest rates and fiscal stimulus.

Nikkei 225 futures traded in Chicago fell sharply after the announcement of the LDP election result.

“The futures market is telling us it’s going to be very ugly on Monday. Normally you would look to buy the dip, but on this occasion you probably want to wait a bit for everything to adjust,” said a trader at one of Japan’s biggest investment banks.

“As more expected Takaichi to win, the yen weakened as she made clear she would not support further rate hikes from the BoJ,” said Ryota Abe, economist at Sumitomo’s Asia-Pacific division Mitsui Banking Corporation (SMBC). ).

The yen rebounded moments after Ishiba was announced as the winner and entered the weekend at around 142 yen against the US dollar. SMBC’s Abe predicted the yen would move in a range of ¥140-145 after Ishiba’s win.

“Expectations for political pressure on future BoJ decisions have probably disappeared. There should be no obstacles to the BoJ offering further rate hikes in the future,” he added.

Masatoshi Kikuchi, chief equity strategist at Mizuho Securities, warned investors that Ishiba’s victory could trigger a reversal of the Nikkei 225’s pre-election rally.

Kikuchi noted that in the run-up to the election, foreign investor confidence in Japan was fragile due to uncertainties about the country’s political direction. In the second week of September, when the LDP leadership campaign began, foreign investors were net sellers of ¥1.5 billion ($10.6 billion) in the cash equity market — the biggest selling week of Japanese stocks since 1982, according to Kikuchi.

Some investors are worried about Ishiba’s willingness to raise taxes on both companies and income from private financial assets, although he has clarified that he will not raise taxes on NISA’s new tax-free investment accounts or individual pension plans with defined contributions.

Any attempt to raise taxes on companies and investors could spark a major pushback and damage the new prime minister’s credibility if he is forced to compromise quickly, stock strategists said.

“Short-term price volatility is likely to persist until Mr. Ishiba can clarify his position on areas of concern to investors, such as corporate governance reform and tax rates on income from financial assets,” Goldman Sachs analysts said in -a note.

Investors are already looking for buying opportunities and compiling a basket of stocks seen as likely to benefit from an Ishiba administration, including those involved in defense and disaster relief. The 67-year-old advocated the establishment of a disaster management agency in the country, which is often hit by earthquakes, typhoons and floods.

Hours after Ishiba’s victory, the top three most searched investment themes on Kabutan, a popular online stock trading site in Japan, were disaster prevention, defense spending and stocks benefiting from the strong yen.

Still, investors said it was unclear how much Ishiba would be able to achieve, given how divided the ruling party remained.

“Although always popular among LDP party members, he has finally won over enough of his colleagues in the Diet who were reluctant to support him before,” said David Mitchinson, portfolio manager at Japan-based specialist Zennor Asset Management. “His lack of a strong personal right in parliament may limit his ability to act.”

The LDP leadership race, which produced a record number of candidates, served as a reminder of how fragmented the ruling bloc has become.

Robert Feldman, an economist at Morgan Stanley MUFG Securities, warned that “major economic policy differences” continue to exist within the party, which will not be resolved by the election of a new party leader.