Japan 's stock market hit record highs on Monday, February 9, following Prime Minister Sanae Takaichi 's landslide victory the previous day in an early general election that secured a two-thirds supermajority in the 465-seat Lower House for her Liberal Democratic Party (LDP).

The Nikkei 225 index rose 3.9% on Monday, surpassing the 57,000-point mark for the first time and hitting a new closing record. The broader Topix index also surged to an unprecedented high of 3,800 points.

The market euphoria reflects the shift away from the deflationary economic policy that had been in effect in Japan in recent years and began to fade when Takaichi, 64, took office as prime minister in October – the first woman to hold the post.

A conservative with populist leanings and an admirer of US President Donald Trump, Takaichi approved a record supplementary budget to implement aggressive government spending programs. The package included increased military spending and plans to boost large state investments in artificial intelligence and semiconductor manufacturing to revitalize the Japanese economy.

The positive market reaction in his first two months encouraged Takaichi to take a risky step – calling early elections just 110 days into his term to secure a majority in the lower house of the Japanese Parliament, where the LDP had to resort to a coalition with the Innovation Party to pass its measures.

In this sense, Sunday's snap election served, in part, as a referendum on public approval of Takaichi's economic agenda. To sway undecided voters, the prime minister anchored her campaign on the promise of a consumption tax cut—a measure that Japan's Finance Ministry estimates could cost more than $30 billion annually.

The proposal caused yields on benchmark government bonds to soar during the campaign, as investors questioned the government's ability to finance the strategy – Japan's public debt is the highest among wealthy countries, equivalent to 237% of GDP. However, one of the main factors driving the current government is the Japanese stock market, which has ignored the volatility observed in the bond market.

The positive election results, although expected, exceeded expectations. The coalition led by the LDP won 354 of the 465 seats in the Lower House of the Japanese Parliament, the party's best result since 1955, when it began its hegemony in Japanese politics.

This guarantees Takaichi's government a majority of more than two-thirds in the Lower House and the ability to override decisions of the Upper House, where the LDP is in the minority, in order to impose its agenda.

Proactive change

The government's decisive victory conveyed the message that voters are willing to embrace what Takaichi called "proactive change in fiscal policy."

"The outcome is extremely favorable for Japanese stocks, particularly in the defense and economic security sectors, as Premier Takaichi now has ample flexibility to pursue her pro-growth economic agenda and advance structural reforms," said David Chao, global market strategist for Asia-Pacific at Invesco, a global investment manager.

"At the same time, yields on long-term Japanese government bonds are likely to face upward pressure, as more proactive fiscal spending aimed at reviving the economy may increase fiscal and inflationary risks," Chao added.

Domestically, Takaichi's main challenge will be to allay concerns in some financial markets that his plans to increase borrowing and spending will not fuel inflation, while simultaneously addressing voter dissatisfaction with stagnant living standards.

In recent years, the prolonged cycle of deflationary stagnation that plagued the Japanese economy has begun to reverse, but families have struggled to cope with the rising costs of some basic items, such as energy and fresh food.

In a positive turn for Takaichi, the inflation that eroded the popularity of several of his predecessors is finally showing signs of moderation. Economists expect consumer prices in February to fall to around 1% year-on-year, for the first time in almost four years.

“Japan’s perennial deflation may finally be easing as wages grow alongside a healthy dose of inflation,” wrote Bruce Kirk, chief Japanese equity strategist at Goldman Sachs Research, in a recent note. “We have a virtuous cycle underway.”

The fear of increased debt, resulting from decades of expansionary fiscal policies, an aging population, and low growth rates, also has mitigating factors. Despite the high level of debt, the country maintains financial stability due to factors such as a large portion of the debt being held by the Bank of Japan (the Japanese central bank), a history of low interest rates, and the strong institutional and monetary credibility of the Asian country.

The magnitude of Takaichi's victory, on the other hand, could lead her to implement controversial measures beyond the country's economic policy. The fact that she obtained a majority of more than two-thirds will give the LDP the opportunity to amend the Japanese Constitution – something that has never happened since the end of World War II.

The aggressive way in which the current prime minister is dealing with China opens the door to approving not only increased military spending but also altering the famous Article 9 of the Japanese Constitution, which prohibits Japan from having armed forces, by establishing that the country renounces war as a sovereign right.

This possibility gained traction after the war of words between Takaichi and the Chinese government in November. At the time, she stated that Japan could be dragged into any military conflict related to Taiwan, which China considers Chinese territory to be taken by force if necessary.

China reacted vehemently, claiming that Taiwan is a purely internal matter. Reprisals included restricting Japanese companies' access to critical minerals and magnets essential to the industry. However, Takaichi refused to retract his statements, asserting that he was merely expressing a long-standing Japanese policy.

Popular support for his stance on China was seen as one of his trump cards in the early election. Takaichi is expected to travel to Washington for a summit with President Trump next month, where, among other things, he will seek assurances that the U.S. remains committed to regional security in Asia. The U.S. has approximately 60,000 troops stationed in Japan.

The alliance with the US reflects Takaichi's pragmatism and the recognition that loosening ties is unthinkable in the face of an increasingly assertive China.

"Japan has no choice but to maintain a close relationship with the U.S. to ensure its security," said Gerald Curtis, a Japan politics expert at Columbia University.