Kan Can Survive Vote of Confidence, but...

Japan Prime Minister Kan faces a vote of confidence as early as tomorrow. It will not cause a split in the Democrat Party of Japan (DPJ). It is a reflection of that split, begun over the ousting of former power broker Ozawa from the DPJ over financing scandal. The DPJ have been divided since this has undermined the government's ability to respond to the crisis.

The DPJ and their allies hold 309 seats in the 480 member lower chamber of the Diet. The vote of no-confidence called by the opposition parties need 240 votes to pass (the speaker does not vote). One incomplete poll in a local paper suggested that some 53 DPJ members by abandon Kan.

If the vote of no confidence passes, then Kan would have to resign or dissolve parliament and call early elections. Although Kan's public support is weak (around 25%), it has stabilized in recently. He is a few days shy of completing a full year in office, a milestone not reached by the past four prime ministers.

If the vote of confidence passes, the DPJ may be mortally wounded. The Liberal Democrats who ran the country until recently would be likely swept back into office and the potential opportunity for political reform dashed again.

A new government, however, may find it easier to push through an agenda. While Kan's budget has been approved, the funding of it through bond sales has not been. Given Japan's fiscal straits, the reconstruction challenge, and effectively dealing with the apparently ongoing nuclear disaster, a national unity government may be the most desired outcome.

If Kan survives the vote of confidence, which is the slightly more likely outcome, he is a weakened leader at moment in time where strong leadership is needed. Among his saving graces ironically may be the lack of a compelling alternative.

The yen itself may not be moved very much on the political machinations. The rally in US and European bonds relative to JGBs has reduced the carry and leaves many participants without a strong yen view. This is reflected in part by the compression of implied volatility, where 3-month implied dollar-yen vol is around 10.5% today, which is the lowest since the coordinated intervention in March.

Meanwhile the foreign appetite for Japanese equities has slowed. Foreigner bought about $10 bln of Japanese equities in each of the first four months of the year, in May it is on pace for "only" about $3 bln. Japanese companies are rebuilding supply chains and production has likely bottomed. The Nikkei appears headed for another test on the 10,000 mark.

Over the past week the dollar has formed a bit of a base near JPY80.70. A break could signal a move back toward the recent lows ~JPY79.60-JPY80.00. Fear of intervention may discourage aggressive yen buying near there, even though intervention is aimed more at volatility than defending a particular level. On the top side, the JPY82.00-25 area proved solid in May. This could mark the range for the coming weeks.