Market Turmoil: Japan’s fiscal expansion shock, Trump tests limits at home and abroad

The surge in Japanese equity investments in late 2025 – nicknamed the “Takaichi Trade” – was spurred by confidence in the newly elected Prime Minister Sanae Takaichi’s pro-business agenda. However, this optimism failed to translate into confidence in her fiscal mandate. Her newly announced budget – proposing an expansion of the fiscal deficit – triggered a sell-off in Japanese Government Bonds (JGBs), with 30-year yields climbing 26bp to 3.9%. This was accompanied by a correction in foreign exchange (FX) markets, causing the Japanese Yen (JPY) to weaken from 148 to 158 since October against the US dollar.

Worried by the ongoing Yen depreciation and the stress on the JGB side, the Bank of Japan decided to intervene on Friday 23rd January in the FX market, in a coordinated way with the US federal Reserve. As the result, the USDJPY dropped towards 152 while the 30Y JGB yield corrected down to 3.65%.

This marks the third episode of BOJ intervention in FX markets over the past four years. Both 2022 and 2024 saw two rounds of interventions totalling USD 58-60bn. Natixis CIB estimates that any second round in the current episode would be smaller, reflecting significantly lower speculative positions in the JPY and the extent of reappreciation already achieved. As a result, the size of a potential follow-up intervention is estimated at USD 10-15bn.

Despite the limited market spillover, this episode does not signal a full recovery in either JPY and JGB markets. Prime Minister Takaichi continues to lead in the polls ahead of general election planned for the 8th of February, suggesting that the fundamental trigger for JGB sell-off will persist if her fiscal expansion plans are approved.

At the same time, the BOJ’s shrinking balance sheet will further limit the pace of recovery. The bank has so far shown no sign of slowing the quantitative tightening (QT) programme announced in June 2024, which halves quarterly bond purchases from JPY 400bn in Q1 2026 to JPY 200bn. The interim assessment of this policy in June 2026 will be critical in shaping the BOJ’s stance heading into 2027.

On the supply side, Japan’s Ministry of Finance has adjusted its issuance policy by increasing short-dated bonds and sub-20Y supply while reducing long-dated issuance. While the gap between the offer of JGB and purchases by the BoJ will tighten ahead, the ongoing imbalances are there to stay, pushing long dated yields up ahead.

In this context, Natixis CIB expects the BOJ to maintain a cautious stance throughout 2026. This will likely involve a single 25bp rate hike in July 2026, alongside only minor adjustments to QT. Meanwhile, 10-year yields will progressively converge towards to 2.5%. The JPY is expected to remain in the 152-156 range in the near term, reflecting current growth and inflation dynamics.

Across the Pacific, US markets remain volatile as President Trump continues to test institutional limits at home and abroad.

One year into the Trump administration, the President continues to challenge the Federal Reserve’s (Fed) independence following its refusal to cut interest rates in line with his wishes. He has attempted to remove Governor Lisa Cook and has launched a criminal investigation into Chair Jerome Powell over funds used to renovate the Fed’s headquarters.

Both actions represent stress tests of the legal and institutional guardrails designed to prevent unilateral presidential control over Fed staffing. Last week, the Supreme Court held a procedural hearing to determine whether Governor Cook can remain in her position while her case is adjudicated. The Court appeared prudent in its questioning, acknowledging existing safeguards that prevent the President from unilaterally dismissing a Fed Governor arbitrarily and without process. While no ruling has yet been issued, Natixis CIB believes this signals that the Court is likely to side with Governor Cook.

In the case of the investigation into Chair Powell, the US Senate has indicated it will not allow the appointment of a new Fed Chair until the investigation concludes. Together, these developments signal the resilience of US legal and governmental institutions in upholding the Fed’s independence.

The President appears less constrained by institutions in the realm of foreign policy. His threat to seize Greenland by force marked one of the most serious challenges to the NATO alliance in its 76-year history. The threat was subsequently retracted following a negative reaction in the US equity markets, highlighting the importance of domestic economic performance ahead of the November 2026 midterm.

Trump is therefore likely to remain a disruptive force on the global stage, willing to strain international relations, but cautious about triggering significant economic fallout at home. Internationally, the experience of Trump’s first year in office points to a longer-term shift in international alliances, with US allies increasingly looking to diversify trade and defence relationships to reduce dependence on the US.

The high levels of uncertainty that defined 2025 show little sign of abating. In Japan, fiscal expansion will continue to weigh on the bond and currency markets as Prime Minister Takaichi moves to increase the national deficit. In the US, President Trump is likely to prioritise limiting economic fallout while continuing to challenge domestic and international institutions.