That was the question raised by Guy Debelle when defending the RBA’s decision to not pursue a more aggressive quantitative easing (QE) program. At face value this seems like an odd concern, after all the Commonwealth government has been issuing debt at an unprecedented level since March last year. Surely the market for Treasuries is deeper and more liquid than ever?
But given this concern was cited as reason why further stimulus was being denied to the Australian economy it is worth exploring the argument in full.
While the total amount of liabilities issued has soared, the same might not be true of the individual bond lines, each of which comprise a separate (though similar) market. When looking at the individual bond lines the 2020 increase is a lot less dramatic. This is because the Australian Office of Financial Management (AOFM) has introduced a number of new bond lines to match the increase in aggregate supply. Even so the median total face value has increased steadily over the past decade as a share of GDP, rising from 0.8% to 1.4%.
An additional $80 billion dollars of purchases of AGS corresponds to roughly 4 percent of GDP - which leaves plenty of scope to increase purchases by the RBA while still keeping the total stock of AGS in private hands within historical norms - if not well above them! Especially since the current stance of fiscal policy means that this line should continue to trend up.
But liquidity is about more than just size. If securities start to be hoarded turnover in the AGS market might fall, signalling a lack of liquidity. The AOFM’s most recent survey of turnover only covers up to September of 2020 (before QE commenced, but after the RBA started it’s yield curve control program), but their data shows that turn over is at record highs.
Both domestic and international investors in Australian bonds are trading them at record levels - little evidence of a looming liquidity problem here.
More timely AOFM data on Treasury auction spreads also finds little evidence on bond market dysfunction.
The above graph shows the spread that the government pays when it auctions off bonds relative to the secondary market. Spreads spiked for a couple days in March when the economy shutdown and bond traders were forced to suddenly work from home. But data from auctions as recently as last week show spreads that are at, or even below, the long term average.
In short despite the large number of purchases already enacted by the RBA, with more on the way, there seems to be little evidence of any negative impact on the functioning of the bond market. Don’t take my word for it. As the AOFM said in a recent report into liquidity “The Treasury Bond market is sufficiently large, diverse and liquid enough to support both substantial and small investors”.
If this mooted crime of bond market dysfunction does exist we have yet to find either a body or the murder weapon!
But this analysis is, frankly, beside the point. Relative to achieving full employment and hitting it’s inflation target, ensuring a well functioning bond market should be a tertiary policy goal of the RBA - at best. That’s the AOFM’s job. And if QE started to impact on bond market liquidity there are plenty of measures they could take to preserve it (eg reducing the number of bond lines it issues).
Even if QE lead to an increase in AGS buy-sell spreads by a basis point or two, this would be more than offset by its impact on lowering longer term interests, signalling an easing of monetary policy and supporting the Australian economy. Indeed if QE starts to become less effective due to bond scarcity that only increases the size of the QE package that the RBA’s mandate demands.