Japan just caught up with the rest of the world

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Today's Points:

Japan's election has stripped the ruling coalition of its parliamentary majority.  Premier Ishiba's intent to carry on increases the political uncertainty. Jay Powell is still chairman of the Fed, for now, despite everything. Tariffs are showing up in US prices — will they start to dent the bottom line? AND: Some Phanatical Astronomy.

Japanese Voters Have Had Enough

It's not just US exceptionalism that has taken a beating this year. The same can be said for Japan's status as the exception to all economic rules. The voters have just rubbed that home by depriving the long-ruling Liberal Democratic Party of a majority in the upper house in the weekend's election. It had already lost its hold over the lower house, leaving Japan's traditional hegemonic party without control of either chamber of the legislature for the first time since 1955. Shigeru Ishiba, who took over as prime minister last year, says he intends to continue, and must now put together a new coalition. At the time of writing, with the breakdown of seats still unclear, prediction markets think his chances of survival, still bad, have improved marginally: The yen has strengthened a bit, showing that markets largely expected this. Bond and equity markets are closed until Tuesday, when a more serious reaction will begin. Equity futures aren't much impacted so far.  Longer term, Japan's shift is undeniable. Jesper Koll, a long-time investment banker in Tokyo who writes the Japan Optimist newsletter, says: Make no mistake — this is about so much more than the tariffs: The ruling LDP's foundational raison d'être was to be America's independent but loyal agent in liberated-by-America-now-democratic Japan; and this core is exactly what is is being disrupted — the emerging realities of America's new national priorities, economic agenda and undemocratic leadership style are, simply put, unacceptable to the Japanese people, thus undermining LDP credibility. In some ways, the voters are ratifying bond markets' verdict. Thirty-year Japanese Government Bonds yield as much as 3% for the first time in more than two decades. The pandemic seems finally to have broken the country's long Ice Age: That can be seen most clearly in inflation numbers. Outside of a couple of ill-judged sales tax hikes, which automatically drove up inflation for a while, Japan's inflation has barely ever exceeded US CPI in the last four decades. That's where it is now: It shouldn't be surprising that Japan's electors are acting like those in most every other country in the developed world, and punishing the politicians who allowed this to happen. That's one critical way in which Japan is no longer so exceptional. Another is in economic growth. Japan's population is falling, so overall gross domestic product can be misleading. Judged by GDP per capita, Japan was ahead of the US and Germany well into the 1990s, and kept pace until after the Global Financial Crisis of 2008. Starting with the "Abenomics" policy adopted in 2012 by the late Shinzo Abe to shake Japan back into life, that changed. It weakened the yen, and in dollar terms GDP per capita sharply parted company with the other two big developed economies: This election is not as dramatic as others of the post-pandemic era, and no full-throated populist alternative is on offer as yet. But it looks like we should assume that Japan has completed normalizing, and not in a good way. It's no longer immune to inflation, and the populace doesn't like that.

The Case for Cuts

In exciting news, Jerome Powell is still chairman of the Federal Reserve. That's a little surprising given the intensity of the pressure on him, but for now it appears that the Trump team is not prepared to take the risk of firing him for cause (with Treasury Secretary Scott Bessent apparently a key figure in arguing against this), and Powell is not going to stand down. The odds of a Plan B in which Powell is a lame duck who faces dissents from his committee but serves out his term until next May are rising:  Why exactly does the administration think it so important to cut rates? With inflation above target, the economy otherwise looking healthy, and stocks, Bitcoin, and gold at or near records, there is little to no evidence that financial conditions are too tight. When he was running for election in 2016, Donald Trump argued that rates needed to rise. Now, it's hard to see a case that he can consistently call for rates to drop all the way to 1%, at least as it concerns the Fed's mandates of inflation and employment. Prior to the GFC, real rates were generally this high: The reason lies exclusively in the need to finance the US deficit. This is what has happened to it, as a proportion of GDP, since 1968: The deficit has been deeper than it is now, but only during recessions and wartime. The current massive shortfall is a product of multiple decisions, but primarily the moves by the first Trump administration and then by Joe Biden to apply massive pro-cyclical stimulus, through the Trump 1.0 tax cuts and then Biden's post-pandemic spending packages. Trump 2.0 arrived with eye-catching attacks on spending via Elon Musk's Department of Government Efficiency (DOGE), but last month's landmark One Big Beautiful Bill Act spurned any attempts to deal with this further — big spending cuts were accompanied not only by extending the Trump 1.0 tax breaks, but by reducing a number of other taxes. The problem: rising long-dated yields make this far more expensive to fund. Government interest payments have climbed in spectacular fashion since the Fed started hiking rates in 2022: It's not part of the Fed's mandate to minimize the federal government's borrowing costs. Congress and the presidency are supposed to do that by balancing expenditures and revenues. That explains why the pressure has redoubled on the Fed in the weeks since the bill passed, with no more orthodox attempt to limit long-term borrowing costs. The Fed cannot set long-term yields, and hasn't attempted to do so since the Treasury-Fed Accord of 1951 gave it independence after years of manipulating interest rates to fund war debts. And it also gives the White House a reason to push for higher tariff rates...

Tariffs Reality

Businesses are getting used to the Trump tariff minefield, but yet another ultimatum is still painful. Washington has often backtracked, but the looming Aug. 1 deadline exacerbates businesses' need to reorganize their supply chains to mitigate the impact of whatever levies eventually result. If tariffs remain on the table even after the post-Liberation Day market selloff in April, and the failure to deliver new trade deals in the ensuing three months, then they are probably here to stay. For managers, acceptance is only just beginning. How they explain their results over the next couple of weeks should tell us a lot; analysis of earnings calls in the second quarter already showed a focus on tariffs that dwarfed by a mile the concern under Trump 1.0: They get such attention from managers because they pose a risk to the bottom line. Except for a handful of trade deals or letters delivered, tariffs on non-exempted goods across all affected countries will likely increase from the current 10% global baseline two weeks from now. Even if this baseline doesn't increase, Boston Consulting Group's Marc Gilbert argues that rates will be approximately four times higher than in January. As complex as navigating the new terrain may be, business strategies are resorting to contingency planning to try to mitigate the impact of punitive levies.  Such strategies include exploring new markets beyond the US. The sheer size of the US market makes it hard to ignore, as evidenced by the surge in nearshoring/friendshoring in recent years, but Gilbert points out that new trade deals are making this approach less likely:  A lot of the tariffs coming to Southeast Asia are essentially linked to the supply base of China-plus-one. They benefited from this move out of China with Chinese capital to serve America until recently. Now, these other nations are also being encouraged, during their deals with the US, to think more broadly and strategically about their relationship with China.  As for inflation, so far, tariffs' transmission into higher prices has been limited. That has intensified the pressure on the Fed's leadership as they await evidence. Indeed, pricing under these circumstances is complicated. BCG argues that companies may be tempted to take advantage of others who are more exposed to the US: It depends on my position relative to my competition. If I'm long assets in the US, then I'm less exposed. If my competition is, they're more exposed. I'll happily watch them get their margins squeezed or watch them take price, and I won't take price and get market share.  June's inflation data vindicated the Fed's cautious policy stance, as does elevated economic uncertainty. Admittedly, uncertainty is nowhere near where it was after the April tariff announcements. This Bloomberg measure of global trade policy uncertainty indicates that current levels are far from the historical norm: The CPI print provided ample evidence that tariffs are boosting prices of exposed goods. For the raw apparel sector, the threat businesses face is existential. They're not high margin and depend on high volume, for which they depend on a foreign supply chain, Gilbert argues. And they're starting to raise prices. This Oxford Economics chart divides the impact on core inflation in the US, depending on whether goods are exposed to tariffs. Increases for other goods remain well under control; those impacted by tariffs are beginning to rise in a big way:  The Oxford analysis indicates that the new tariffs, if fully implemented, would reduce US GDP growth by 0.1 percentage point this year and 0.3 percentage points in 2026, thanks to a rise in core inflation. The dilemmas for companies, and central bankers, aren't going away.  —Richard Abbey

Survival Tips

It's cruel to enjoy others' discomfiture. Marital infidelity is serious. And it's terrible when someone has to lose their job. All that said, the fallout from the incident when the Astronomer CEO Andy Byron was caught on the Jumbotron at a Coldplay concert with his arms around a woman not his wife is just irresistible. For future reference, it's their guilty reaction that made it quite so funny; a lesson for all of us when we do something we shouldn't. And for a take on it that I can't get enough of, watch how the Philadelphia Phillies and their mascots the Philly Phanatics paid homage. Just great. Have a great week everyone.  More From Bloomberg Opinion Max Hastings: Why the World Is Haunted by This White House Justin Fox: New York City's Subway Is Actually Safer Than Your Car Matthew Ygelesias: Bipartisan Outrage Over Epstein Is Just What America Needs

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