Japan's market is undergoing a significant turning point, with a fundamental shift in market pricing logic. Following the Liberal Democratic Party's landslide victory in the Lower House election, the Japanese yen yield curve has flattened, inflation expectations have stabilized, and the yen has strengthened—exhibiting the typical response of a developed market facing expectations of higher real interest rates. On February 14, according to消息 from Zhuifeng Trading Desk, Goldman Sachs pointed out in its latest research report that the market has begun pricing in the possibility of Japan exiting its ultra-low real interest rate regime, rather than merely viewing it as an inflation shock. The core driver of this change is investors assigning higher probability weight to expectations of asset repatriation and an exit from the ultra-low real interest rate regime. However, significant uncertainty surrounds the sustainability of this shift. Goldman Sachs warns that if the Bank of Japan (BOJ) fails to deliver on the market's expected hawkish path, previous market dynamics could return, leading to a weaker yen and increased volatility in long-end yields. The report specifically notes that the key risk centers on the BOJ's policy path. Any dovish signals from the BOJ regarding accelerating the pace of rate hikes—especially considering the yen's recent strength—would likely catalyze a return to pre-election trading dynamics. **Fundamental Shift in Market Pricing Logic** According to the report, two weeks ago, Goldman Sachs' analysis team proposed a framework to understand the performance of Japanese government bonds and the yen under the current policy mix. The logic then was that when policy rates are constrained, inflation is rising, and fiscal policy is planned to be expansionary, simultaneous weakening of bonds and currency is a reasonable market reaction. Goldman Sachs noted, however, that post-election markets have shown截然不同的 dynamics. Real interest rates have risen slightly, while forward inflation expectations have edged down. Stock prices have risen, accompanied by a flatter nominal yield curve and a stronger yen. The bank believes this cross-asset class correlation is clear and consistent, aligning with typical correlation patterns of developed markets when actual inflation is near target levels. Data shows that since the second half of 2025, the trajectories of 2-year and 3-year forward real swap rates and inflation swap rates have diverged significantly, with real rates steadily rising and inflation expectations stabilizing. **Asset Repatriation Expectations Become Core Driver** Goldman Sachs believes the key to the shift in market pricing logic is that investors have begun incorporating a higher probability weight on portfolio flow repatriation and an exit from the ultra-low real interest rate regime. Combined with expectations for new fiscal measures, these market movements primarily reflect pricing for an increased likelihood of repatriation of assets from Japan's net international investment position. The report states that some investors interpret recent remarks by the Finance Minister as signaling support for the repatriation of foreign assets. Given Japan's strong net international investment position, utilizing overseas assets to fund new fiscal expansion, or shifts in private sector portfolio flows and FX hedging, could stabilize the yen and boost other domestic asset prices. Notably, recent market movements have significantly narrowed the gap with Goldman Sachs' model predictions. The actual level of the 10-year to 30-year JGB spread is now close to model-fitted values, indicating that post-election, the market is indeed pricing a different regime. **BOJ Policy Path Faces Test** Whether current market dynamics can persist depends critically on whether Japan can truly exit the ultra-low real interest rate regime. Goldman Sachs points out that Japan's institutional challenges and policy debates could make this transition difficult or more prolonged. Goldman Sachs believes that if the yen's recent strength continues, the BOJ is likely to become more complacent, potentially reigniting pre-election dynamics where a weaker yen was a key prerequisite for faster rate hikes. Given current pricing of the policy path and the market's exploration of the possibility of exiting the low real interest rate regime, any dovish signals from the BOJ regarding accelerating the pace of rate hikes would likely catalyze a return to pre-election trading dynamics. In terms of the policy path, the market currently sees only the March meeting offering a compelling risk-reward ratio, pricing in 7 basis points. According to the report, even if the risks of a weaker yen and steeper long-end curve re-emerge, this would not constitute an inflation equilibrium for Japan. Goldman Sachs believes that without a decline in the inflation outlook, volatility in the mid-curve (around 5-year) interest rates is unlikely to decrease. Data shows a clear correlation between the 5-year to 30-year swap spread and the volatility spread. As the 5s30s swap spread has risen from approximately 0.8% in early 2024 to current levels, the implied volatility spread between 30-year and 5-year has also widened significantly. Goldman Sachs believes this volatility pattern suggests a greater risk of yen yield curve flattening over the longer term. The report notes that in the short term, during the information vacuum over the next few weeks, current market conditions may extend further. However, Goldman's inclination is that this "may have come too far, too fast." If the BOJ uses the yen's recent strength as an opportunity to maintain a more gradual rate hike path, yen weakness and increased long-end yield volatility could follow.