There's a familiar pattern playing out in Japan right now, and it's one that traders know well: a sinking yen and soaring stocks moving in perfect opposite directions.

The Japanese yen just slid to its weakest point since July 2024, breaching the 159 level against the dollar. Meanwhile, domestic equities are doing the exact opposite—ripping to record highs and leaving most global markets in the dust.

The Classic Trade Is Back

On Tuesday, the yen weakened past 159 against the U.S. dollar, pressured by rising political uncertainty. The catalyst? Speculation that Prime Minister Sanae Takaichi might dissolve parliament as early as next month.

Takaichi enjoys strong public approval and is widely seen as favoring expansionary fiscal policy. Markets have interpreted that stance as a green light for further yen weakness, and they're acting accordingly.

Japanese stocks, meanwhile, are having a moment. Futures on the Nikkei 225 jumped 3.1% to fresh record highs on Tuesday, powered by exporters and financial stocks that benefit when the yen softens.

Toyota Motor Co. (TM), the largest component of the Nikkei, surged more than 7% in Tokyo trading. Mitsubishi UFJ Financial Group Inc. (MUFG), the index's second-largest holding, gained over 5%.

Year-to-date, the iShares MSCI Japan ETF (EWJ) has climbed nearly 5%, comfortably outpacing the SPDR S&P 500 ETF Trust (SPY), which is up just 1.6% over the same period.

So everything's great, right? Not so fast. Some experts are starting to sound the alarm about what's happening beneath the surface.

The Warning Signs Are Piling Up

Economist Mohamed El-Erian pointed out that Japan is experiencing a historically unusual combination for a G7 economy: persistent yen weakness paired with rising bond yields. He called the dynamic "worrisome" if it continues.

Adam Turnquist, an analyst at LPL Financial, tied the yen's decline directly to election speculation.

"The yen has fallen to its weakest level against the greenback since last January amid speculation that Prime Minister Sanae Takaichi may call a snap election," said Turnquist.

He noted that markets have welcomed Takaichi's pro-growth agenda, even as both bonds and the yen have struggled since she took office in October. The tension? Takaichi favors easier fiscal policy, while the Bank of Japan is raising rates to combat inflation.

That creates a problem. As Turnquist pointed out, Japanese authorities intervened four times in 2024 when the yen weakened toward the 160 area. That level is now firmly back on traders' radar screens.

Speculative positioning adds another layer of risk. Long yen positions have dropped to their lowest levels since early 2025, while short positions remain elevated. That setup raises the possibility of a sharp reversal if momentum shifts suddenly.

How much further can the yen fall before officials step in? Bank of America sees election risk as the key near-term driver.

"The potential snap election is likely to become a short-term theme in the yen asset market," said Shusuke Yamada, an analyst at Bank of America.

In the short run, markets appear to be pricing in what some are calling "Sanaenomics": looser fiscal policy, accommodative monetary conditions, a steeper yield curve—and a weaker yen.

"The market may see further yen weakness and curve steepening unless the report is denied by the administration," Yamada said.

According to Yamada, intervention becomes more likely in the 162–165 range, unless yen selling accelerates sharply over a short period.

The longer-term outlook remains murky. The administration has shown pragmatism so far, attempting to balance growth objectives with market stability. But aggressive deficit spending could renew selling pressure on both the yen and Japanese government bonds.

"The medium- to long-term impact on the market remains uncertain at this stage," Yamada said.