BOJ May Engineer a Reverse ‘Operation Twist,’ Evercore ISI Says

Is Massive Stimulus on Deck for the Bank of Japan?
  • Steeper yield curve could alleviate risks Kuroda has noted
  • Challenge would be avoiding impression of reduced stimulus

Japan’s central bank in coming weeks will probably modify its stimulus program to alleviate risks from ultra-low long-term yields, according to Evercore ISI.

The change would help to make the Bank of Japan’s easing more sustainable over the longer haul, given diminishing chances of hitting the 2 percent inflation target soon, according to the analysis by Krishna Guha and Ernie Tedeschi, Washington-based analysts at the research group.

Bank of Japan Governor Haruhiko Kuroda on Monday pointedly flagged concerns about negative potential effects from the slide in long-maturity bond yields. Earlier this year, rates as long as 20 years touched zero percent. The BOJ chief noted that the drop hurt returns on pension programs, and could affect confidence levels and the economy more broadly.

Kuroda’s remarks came little more than two weeks ahead of the results of a comprehensive review of BOJ policy, which culminates at a Sept. 20-21 meeting.

“The BOJ’s policy review will point to a rebalancing of its monetary policy aimed at maintaining or increasing downward pressure on short-to-medium term real interest rates (and in turn put downward pressure on the yen) while engineering a steepening of the yield curve,” Guha and Tedeschi wrote in a note.

To read more about the BOJ’s policy review, click here.

By steepening the yield curve, the BOJ would be mounting a “reverse Operation Twist,” the Washington-based analysts wrote. In the original Operation Twist in the 1960s, U.S. policy makers were attempting to shrink the gap between short and long-term yields. Now, focus is rising on the dangers of too-low longer term yields.

“Some business firms have revised down their profit forecasts due in part to the increase in the net present value of retirement benefit obligations,” Kuroda said in a speech Monday. “We should take account of the possibility that such developments can affect people’s confidence by causing concerns over the sustainability of the financial function in a broad sense, thereby negatively affecting economic activity.”

Communication Challenge

Guha previously worked at the Federal Reserve Bank of New York and now serves as vice chairman of Evercore ISI, and Tedeschi served at the U.S. Treasury before his current post. They highlighted the challenge of the BOJ engineering a shift in policy to steepen the yield curve without giving the impression that it’s reining in stimulus -- something Kuroda has repeatedly said won’t result from the review.

A cut in the already-negative benchmark rate, levied on a portion of banks’ reserves parked at the BOJ, which would also steepen the yield curve, could show the BOJ is still implementing unvarnished stimulus. The Evercore ISI analysts said a rate cut could come either this month or later in the year.

The BOJ could additionally add local-government or nonfinancial corporate bonds to its asset purchases. Another option could be to pledge an “overshoot” of the 2 percent inflation target, which would suggest avoiding any shrinkage of the balance sheet for an extended period.

A core part of the operation would be shifting government debt purchases to shorter maturities, “allowing ultra-long term yields beyond 10 years in particular to rise,” Guha and Tedeschi wrote.

“The combination of credible aggression today with a commitment to maintain that and the associated balance sheet/rate settings longer into the future would in our view make the policy additionally effective,” they wrote.

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