Trend of weaker yen and lower yields to continue, but watch for the risk of JGB operation failing

The potential for JGB sales by public institutions makes it unlikely that QQE will become unsustainable at least for another year. In an environment of low interest rates, low liquidity, and a growing JGB portfolio at the BoJ, however, the risk of a failure in its JGB buying operations increases by the day. 

It is not difficult to imagine the possibility of a series of failed operations creating doubt in the market over the sustainability of QQE and the feasibility of the monetary base target.

Under such a risk scenario, it is conceivable for the yen to strengthen initially despite falling interest rates. Nevertheless, if the BoJ continues offering to buy JGBs at the current pace, yields will remain under downward pressure, making a complete reversal of the long-term yen weakening trend unlikely. 

In the event of an extreme strengthening of the yen, it is not inconceivable that the BoJ might pursue rate-based easing by cutting the IOER. In that case the BoJ's policy mix would be closer to that of the ECB, that would put a break on yen appreciation and lead to twist-steepening of the JGB curve. 

BOFA Merrill says the QQE will keep yields lower and gradually weaken the JPY.