BoJ may implement operation twist - AmpGFX

Greg Gibbs, Director at Amplifying Global FX Capital, suggests that at the top of this list of uncertainty is Japanese financial markets as they appear to be spilling over to volatility in other markets and there is a risk that this spills over to broad global risk aversion and sharp correction in asset prices.

Key Quotes

“The rapid appreciation in the JPY this year is not easy to explain considering that Japanese rates and yields fell increasingly into negative territory.  Conventional thinking would suggest that negative rates and yields should weaken the exchange rate. But the rising JPY itself helped drive Japanese yields lower, undermining corporate profits and inflation expectations. 

While the BoJ appears to have run out of willingness or scope to further significantly expand monetary policy easing (even though they claim otherwise), the severe flattening in its yield curve, resulting in weaker financial institutions’ profits, detracting from economic confidence, appears to have convinced them to rejig existing policy to allow longer term rates to rise.

The BoJ claims that it has no intention of reducing the “level” of monetary policy easing.  As such, if it would like higher longer term yields then it might be planning to lower short-term yields.  This suggests that it may edge lower its cash rate target below -0.1%.

They seem to argue against a major change in the level of policy, but want to reset policy to be more sustainable for a long fight against deflation.  The most sensible approach may be a modest further cut in NIRP, pushing down short-term yields and less buying of longer-term bonds to target somewhat higher longer-term yields. The Japan version of operation twist.

But market commentary appears quite confused over what the BoJ plans on 21 September.  BoJ watchers emphasise a diversion of opinion on the BoJ MP board, suggesting there is a range of possible outcomes ranging from some adjustment in QE purchase targets and/or some cut in the cash rate target, or no change.  Some argue the BoJ will wait for the outcome of the 21 September FOMC meeting, suggesting no change in BoJ policy until at least 1 November (but of course this would also be just ahead of the next FOMC meeting, although few see an FOMC policy shift days before the US election).

The BoJ has pointedly refused to say almost anything about the strength in the JPY this year, despite it being the elephant in the room.

Japanese bond markets appear to be betting on a reduction in long-term bond purchases more than they are betting on a deeper NIRP.  The chart below shows that the yield curve has steepened somewhat but mainly it has experienced an overall rise in yields since the day before the 29 July policy meeting.

Nevertheless, 10-year JGB yields are still below zero, so presumably the BoJ might like these and super long-term yields to rise further yet.

While there has been a modest fall in 2yr and shorter term rates recently, they remain relatively steady and only very modestly below zero, suggesting the market is doubting the BoJ will lower the NIRP much if at all.  As such, there still seems to be considerable scope for market upheaval if the BoJ adopts a deeper NIRP.”