The Twist operations carried out by the Fed from July 2011 to the end of 2012 aimed to reduce long-term yields through massive purchases in order to encourage borrowing and economic recovery. At the same time, the Fed sold more short-term bonds, leading to an increase in their yields and a flattening of the yield curve.
Conversely, the possible « reverse twist » mentioned in the case of Japan would correspond to an increase in the yield on long-term bonds achieved by the Central Bank stopping quantitative purchases on these maturities, with purchases being shifted to medium-term maturities. At the same time, the BoJ would lower its deposit rate into even more negative territory to encourage a complete steepening of the yield curve, in particular to put pressure on real yields on short- and medium-term bonds, which would weaken the yen and boost economic activity in Japan.
Two risks: (1) further affecting bank profitability – to counter this, the BoJ would offset the deposit rate cut by steepening the yield curve, which would have a net positive effect on the banking system; (2) affecting activity by increasing long-term yields – to do this, the BoJ would sell very long-term bonds to avoid affecting the economy.
On this last point, the justification relates to the concept of the natural yield curve. If the actual yield curve is equal to the natural yield curve, then the output gap is zero. If the actual curve is higher than the neutral curve, then economic activity comes under negative pressure and financial conditions deteriorate. If the actual curve is lower than the neutral curve, financial conditions ease, which boosts economic activity. However, this gap is now more negligible for maturities of over 20 years. Stopping purchases of very long-term bonds would therefore have only a very marginal impact on the economy.
In summary, the Bank of Japan would: (1) lower its deposit rate, (2) stop purchases of very long maturities, and (3) substitute these unrealized purchases with short- and medium-term maturities in order to flatten the yield curve (improving bank profitability) and maintain yields that promote economic activity (lowering medium-term rates of 5-10 years).
Bank of Japan: Monetary policy meeting on September 21.
Results between 4 and 6 a.m.
