TOKYO -- A double-barreled blast of bond buying by the Bank of Japan did little to weaken the yen on Friday, as the test of wills continues between the central bank and the investors who suspect it is readying to retreat on massive monetary easing.
Market watchers were surprised by the timing of Friday's fixed-rate purchasing operation, in which the BOJ names a yield and offers to buy an unlimited amount of Japanese government debt at that level. Since its introduction in 2016, this has been regarded as the bank's ultimate weapon for keeping the 10-year yield at its target of around zero.
But this time, the BOJ brandished it when the benchmark long-term interest rate was at 0.095% -- lower than the 0.105% that prompted the same move last July. Friday's move came "surprisingly early," said Makoto Suzuki at Okasan Securities in Tokyo.
Before Friday, markets appeared to be testing how far the BOJ would allow interest rates to rise before acting. Now, the central bank appears to have drawn a line.
At the same time, the BOJ increased Friday's scheduled purchases of bonds with five to 10 years of residual maturity by 40 billion yen ($363 million) over the previous round last Monday. The 10-year yield was driven back to 0.085%, and the bond market "saw once again that it's useless to fight the BOJ," said Kazuhiko Sano at Tokai Tokyo Securities.
But the foreign exchange market proved harder to nudge. While the BOJ does not target exchange rates directly, a weaker yen is in line with a goal of stoking inflation.
The Japanese currency stood in the low 109 yen range against the dollar before the BOJ announced the fixed-rate operation, and it slipped about 0.2 yen immediately after. But the yen later pared its losses and even moved higher.
Mizuho Bank's Dai Sato reckons that short sellers had placed negative bets on the yen in anticipation of a fixed-rate operation. When the yen sold off less than expected, they unwound those positions, which drove up the currency, Sato said.
A wider gap between Japanese and U.S. interest rates should help weaken the yen against the dollar. But the upward pressure on the Japanese currency shows little signs of abating, despite widening interest rate gaps due to the rise of U.S. long-term rates to nearly 2.8%. One reason for the apparent breakdown in the correlation between the spread and exchange rates is speculation that the BOJ is preparing to start normalizing its monetary policy.
The yen gained sharply after the BOJ cut its purchases of ultralong-term Japanese government bonds on Jan. 9, a move some in the financial markets interpreted as the central bank heading for the exit from unprecedented quantitative easing.
BOJ Gov. Haruhiko Kuroda rejected that idea at a news conference following the bank's Jan. 23 policy meeting, saying "we are not at the stage for considering an exit." Then came Friday's increase in bond purchases. Yet even with the fixed-rate operation, Friday's actions by the BOJ drew only a somewhat muted response from the market.
Although several members of the BOJ's nine-member board argued that the bank needs to weigh changes to its easing policy, most do not expect it to change course any time soon. It is clear that even debating the issue would provide fodder for investors seeking to bid up the yen.
There is also the risk that rising U.S. and European interest rates will pull Japanese rates higher, bringing an unwelcome run-up in the yen. It is not easy being the BOJ leadership these days.