JPY should weaken on BoJ operation reverse twist - AmpGFX

Greg Gibbs, Director at Amplifying Global FX Capital, suggests that there is no guarantee that by simply buying less long-term bonds, the BoJ will achieve a weaker JPY, although a lower NIRP would more clearly help weaken the JPY, increasing the cost of hedging foreign investment.

Key Quotes 

“However, if the BoJ buys less long term bonds and yields rise and encourage more demand from the private sector in Japan, it will mostly draw funds away  from hedged Japanese investment in foreign bond markets (not unhedged) and thus it will not generate additional demand for JPY.

This should increase yields in foreign bond markets.  Combined with the higher cost of hedging in Japan (via a lower NIRP), higher yields abroad will increase the return on unhedged foreign investment in Japan, and thus may encourage more Japanese sales of JPY. In addition, it might encourage more carry trades, selling JPY by global investors. This may improve the effectiveness of NIRP, which arguably is designed to weaken the JPY.

When NIRP is achieving its goal of a weaker exchange rate, boosting inflation expectations, it should tend to be associated with a positively sloped yield curve.  Almost by definition, if NIRP results in a flat yield curve with negative yields across a wide spectrum of maturities, it is not working.  At this point, central bank buying longer-term bonds may be counter-productive.  And this appears to be the case in Japan.

As such, the simple act of buying less long-term bonds, helping restore a more normal shaped yield curve may improve the optics of BoJ policy, tend to help lift confidence, inflation expectations and contribute to reversing an irrational and unsustainable pattern of strength in the JPY.”