Tail risk 4: Bo) triggers curve steepening and vol rise Bo) keeps yield curve anchored out to 10y: 1y10s20s conditional bear steepener The Bank of Japan (BoJ) has faced a tough 2016. Having switched its policy target from quantity to interest rates at its September Monetary Policy Meeting, it tacitly acknowledged that negative rates and JGB purchases were potentially approaching their limit in terms of policy effectiveness. Inflation expectations fell and the yen strengthened as a consequence as the market got accustomed to fading dovish pronouncements from the Bank of Japan. Bo) Governor Haruhiko Kuroda himself said “Central banks are, admittedly, not omnipotent." The Bo) introduced yield curve control, taking into consideration negative effects of great decline in yields and curve flattening on financial institution earnings or financial markets. If the Bo] keeps purchasing at the current rate, however, yields will sooner or later feel downward pressure. We believe the Bo) is likely to reduce its long-term )GB purchase gradually. For the time being, JGB yield guidelines are probably around 0% for the 10yr, 0.4% for the 20yr, and 0.5% for the 30yr JGB. However, the Bo) appears to be concerned about the deterioration of financial institution earnings caused by flattening of the yield curve. Kuroda said that even if superlong-term yields rose slightly, he did not believe they would have to be lowered. He went on to say he was also giving consideration to investors in superlong-term bonds, and that he did not think it was good for the yield curve to get continually flatter. Based on these and other remarks, we expect long-term JGB purchase operations to be reduced and the curve to gradually steepen (Rates forecast: Attention on Bo) operations when yields decline). Before that can happen, however, preconditions most likely include steady progress in US rate hikes, avoidance of excessive yen appreciation, and some degree of recovery in the inflation rate. With a Republi