What Pythagoras’ theorem can teach us about the Fed

Sanae Takaichi, nicknamed the ‘Iron Lady’ after her inspiration, former British Prime Minister Margaret Thatcher, won the Liberal Democratic Party (LDP) leadership election on 4 October. With the LDP holding the most seats in the National Diet, Takaichi is set to be confirmed as Japan’s first female Prime Minister on 15 October.

Takaichi’s win came as a shock, with the ‘Iron Lady’ beating the frontrunner in the polls, Shinjiro Koizumi, in a runoff vote after no candidate secured enough votes for victory in the initial voting.¹

The ‘Iron Lady’ nickname is where the similarities between Thatcher and Takaichi end. While Thatcher’s government is remembered for its fiscal discipline, Takaichi is a protégé of former Prime Minister Abe and is an ‘Abenomics’ advocate.² As such, she is expected to seek a more expansive fiscal policy to support gross domestic product growth in Japan. This is a policy which could put pressure on the long end of the Japanese government bond (JGB) curve, with the yield on the 30-year JGB already hovering around all-time highs due to fears over a lack of fiscal discipline (see Chart 1).

Chart 1. 30-year JGB yield (%)

Source: LSEG Data & Analytics and EFGAM calculations. Data as at 06 October 2025.

Ahead of the election, when Koizumi was the favourite in the polls, the JGB curve experienced a ‘bull flattening’.³ This is a situation in which yields for government bonds at the long end of the curve fall by more than yields for government bonds at the short end of the curve, making the slope of the yield curve flatter. Thus, after Takaichi’s election, one could expect the yield curve to reverse this process and experience a bear steepening, where the yields on government bonds at the long end of the curve rise by more than yields for government bonds at the short end of the curve.

However, expectations for a significant increase in fiscal spending may be overdone. The LDP does not have a majority in either house of the National Diet, meaning Takaichi will need to seek the support of smaller parties which will have a disproportionately greater role in policymaking than their number of seats would usually suggest. As such, Takaichi’s policy plans may be diluted.

Takaichi has previously expressed her dissatisfaction at Bank of Japan (BoJ) policy rate increases.⁴ This has led to commentators questioning the degree of independence the BoJ will have under Takaichi’s premiership and whether her preference for low interest rates will halt the central bank’s rate normalisation process.

Such questions are understandable given the current climate in which the Fed’s independence is being challenged by President Trump. Nonetheless, we believe the ‘Iron Lady’ being elected may put the BoJ’s rate normalisation process on hold but will not altogether end it. Governor Ueda will want to resist the BoJ getting drawn into uncertainty regarding its independence, and high inflation has meant that the real policy rate is extremely low (see Chart 2).

Chart 2. BoJ real policy rate (%)⁵

Source: LSEG Data & Analytics and EFGAM calculations. Data as at 06 October 2025.

BoJ staff have estimated a range for the neutral real policy rate of between -1% and -0.5% and current BoJ inflation forecasts imply between two and three further 25 basis point rate hikes would be required to take the central bank’s policy rate to neutral in fiscal year 2026.⁶

In addition, the Trump administration has repeatedly emphasised its desire for higher rates in Japan and a stronger Japanese yen (JPY).⁷ Takaichi will be keen not to tempt Trump into using tariffs as a negotiating tool. Given the desire to protect the bilateral trade deal agreed with the US in July which the ‘Iron Lady’ has committed not to renegotiate, she is unlikely to pressure the BoJ into a more accommodative monetary policy than economic conditions suggest is appropriate.

To summarise, Japan is likely to see a marginally more accommodative fiscal policy under the premiership of Takaichi, though her policy plans could be diluted by the LDP’s lack of majority in both houses of the National Diet. The Bank of Japan is likely to continue its rate normalisation process at a gradual pace but could be on hold for a while until the dust has settled.

The above analysis alludes to a scenario which is positive for Japan’s stock market given the more accommodative fiscal policy. This conclusion is supported by the initial market reaction, with the Nikkei 225 Index rising 4.75% to record highs from the election to the time of writing. At the same time, concerns over fiscal discipline and circling bond vigilantes suggest renewed volatility for the long-end of the JGB curve and the JPY. Indeed, 30-year JGB yields have risen 13 basis points and the JPY has depreciated 2.0% against the US dollar in the first trading day since Saturday’s election.⁸

¹ https://asia.nikkei.com/politics/japan-leadership-race/japan-ldp-election-koizumi-leads-race-for-party-head-analysis-shows
² The “three arrows” of ‘Abenomics’ were monetary policy easing, fiscal stimulus through government spending on infrastructure and tax incentives, and structural reforms to boost women’s labour force participation.
³ https://www.reuters.com/markets/asia/foreign-investors-stand-gain-twist-japans-bond-yield-curve-2025-09-24/
⁴ https://www.wsj.com/articles/japans-next-prime-minister-could-make-rate-increases-tricky-for-bank-of-japan-20396126
⁵ The BoJ real policy rate is calculated by subtracting year-on-year core CPI inflation from the BoJ’s policy rate.
⁶ The Bank of Japan forecasts core CPI inflation of 1.8% in fiscal year 2026, implying a policy rate between 0.8% and 1.3% would be viewed as neutral.
⁷ https://www.ft.com/content/5fa8c360-dcb3-4cb2-a2ef-14898131fb4c
⁸ Market data from the FT and LSEG Data & Analytics. Data as at 06 October 2025. Past performance is not indicative of future results.