Tag: government debt

Bond market vigilantes

Government bond holders were the playground bullies of the 80s and 90s. They would threaten governments and central banks with bond sales to get what they wanted – usually fiscal discipline and lower inflation. Bond vigilantes – a self-appointed nickname – was presumably a way to sound more like Batman and less like thugs. Like everyone who picks their own nickname, they had high opinions of themselves:

“Bond Investors Are The Economy’s Bond Vigilantes.” I concluded: “So if the fiscal and monetary authorities won’t regulate the economy, the bond investors will. The economy will be run by vigilantes in the credit markets.”

The guy who coined the name in 1983
Alan S. Blinder: Return of the Bond Market Vigilantes - WSJ
Credit to Chad Crowe at the Wall Street Journal

These threats worked because selling government bonds causes their price to fall, and the yield – the interest rate – to rise. A government bond is just an IOU from the state, so higher interest rates make it more expensive for governments to borrow. Higher interest rates in government bond markets also usually increase interest rates elsewhere in the economy, slowing down growth. Governments, especially smaller, fiscally precarious ones, had reason to be afraid.

Their reputation was cemented when Bill Clinton’s campaign strategist James Carville said: “I used to think if there was reincarnation, I wanted to come back as the President or the Pope or a .400 baseball hitter. But now I want to come back as the bond market. You can intimidate everyone.”

Quantitative easing mostly killed off the bond vigilantes. Central banks have bought trillions in government bonds since the GFC, making the threat of a bond vigilante sell-off mute. Sell all you want, the central bank will hoover it up.

Or did it? The deluge of fiscal and monetary stimulus, vaccines, and the beginnings of a recovery have some worried about inflation – a concern I’ve discussed previously. Bond holders hate inflation because it erodes the value of their (usually) fixed coupon payment. Because they hate inflation, bond holders tend to be wary of government spending. A world where governments are planning trillions of new spending has the vigilantes reaching their capes and masks. The FT reports:

It’s probably premature. Bond yields have slumped again after reaching record highs last week. The Reserve Bank of Australia brought forward bond purchases in response to yields rising. It’s hard to fight a central bank.

Bond vigilantes bring together history, macroeconomics, markets, and superheroes in a neat bundle. I recommend further reading:

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YCCATRBA

YCCATRBA almost sounds like a cool new hip hop track no?

But it’s even better: Yield Curve Control at the Reserve Bank of Australia

Anyway.

At the Reserve Bank of Australia’s (RBA) December 1st meeting they voted to keep all policy options unchanged. This includes its target of maintaining 0.1% on three year Australian government bonds, a policy also known as Yield Curve Control (YCC).

YCC was first announced in March, with the RBA committing to buy any quantity of Federal Government and semi-government (e.g. state government) securities required to reach its yield target. The target was set to 0.25 in March, and lowered to 0.1 in November.

One of the concerns about YCC is that the commitment is open-ended. If investors got skittish and started selling bonds, causing yields to rise, the central bank would have to step in and purchase potentially enormous quantities of bonds.

The alternative approach is the quantitative easing practiced overseas, where the central bank commits to buying a certain quantity of bonds, but does not commit itself to achieving a set target for yields. This limits the central bank’s commitment.

In both cases the goal is to shift portfolios to other assets and reduce borrowing costs. The question is which requires the central bank to do less?

RBA Government Security Purchases
Purchase DateQuantity
(Billions AUD)		Total (Billions AUD)Purchases as a % of outstanding long-term government securities
March3636.04.3
April1450.05.9
May*151.05.8
June*051.05.5
July*051.05.3
August1061.06.1
September263.05.9
October0.063.0No data on outstanding securities
November5.068.0No data on outstanding securities
Data drawn from the RBA outstanding debt securities database and purchases announced in monthly monetary policy decision press release.

Still, this quick and dirty calculation suggests the RBA has been able to anchor long-term rates quite quickly at minimal cost.** This is good news for advocates of YCC, especially when you consider that QE has left the Fed and the Bank of Japan with bond holdings in excess of 30% or 40% of GDP.

Lets quickly take a look at this from the Government’s perspective (drawing on the Australian Office of Financial Management’s data). We see an increase in long-term security issuance from April, just after YCC began. At the same time, short-term security issuance starts to decline from May. In other words, the government is taking advantage of the RBA’s effort to keep longer term borrowing costs down and loading up on longer-term debt.

Interestingly, this surge in issuance does not seem to be putting pressure on the RBA’s peg. Between May and July, the government raised nearly $100 billion in long-term debt. I do not have data showing breakdowns by maturity, but presumably some quantity of that was 3-year debt. Despite the increase in issuance over the period, the RBA did not need to purchase more bonds to maintain its peg.

There is clearly plenty of demand for government debt right now. The risk is that if private demand for public debt at that price were to decline (for whatever reason), then the RBA would need to purchase ever larger quantities of the debt to maintain the peg. For now, that does not look like a concern.

As I’ve said before, the government should take advantage of this to borrow for an ambitious investment program. I remain skeptical of stimulus overly reliant on tax write offs and incentives.

The RBA separately announced a more traditional $100 billion QE program last month, with 19 billion already purchased. I will revisit these figures once more data on debt issuance becomes available.

*A small purchase was made in May but it did not change the overall quantity, so was probably below $1 billion in size. June and July had no purchases.

**The calculation is not perfect because I don’t have data on how exactly the RBA is spreading its purchases along the yield curve, and whether they are also purchasing short-term treasuries.