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The expectations channel and The expectations channel and mmonetary onetary policy operationspolicy operations inin Asia-Pacific bAsia-Pacific bond ond mmarketarketss
Eli Eli M RemolonaM RemolonaHead of Economics for Asia and the PacificHead of Economics for Asia and the Pacific
Workshop on Developing Government Bond Workshop on Developing Government Bond Markets: Challenges towards Sound Monetary Markets: Challenges towards Sound Monetary Management Management Bali, October 31 - November 1, 2007Bali, October 31 - November 1, 2007
Informational underpinnings of government bond markets
A two-way street: central banks and bond markets can help each other
Liquid government bond markets need information about monetary policy
Expectations channel relies on bond markets
Information in deeds: monetary operations in Asia and the Pacific
Choice of operational policy target
Operational adjustment of target
Information in data and words: the US experience
Implications of transparency in bond market
Implications of expectations management
Mechanics of expectations channel
Operational policy target is short rate – “an interest rate that is relevant to virtually no economically interesting transactions” – Blinder (2006)
Effect is through longer maturities in yield curve
Investors make guesses about future policy rates
Yield curves embody these expectations as well as uncertainty surrounding them
Why not target long rate?
May be way to avoid liquidity trap
But forecastable change in target implies large spikes in short rates on day of target change – Woodford (2005)
Information to build yield curve
Gradualism and reversal aversion
Data and words to manage expectations
Policy rate targets and markets for operations in Asia and the Pacific
Policy rate targetMarket for operations
Australia Cash rate (overnight) Repo
India Repo (overnight) Repo
Indonesia One-month SBI SBI auction
Japan Overnight call rate Repo
Korea Overnight call rate MSB/repo
Malaysia Overnight policy rate Tender/repo
New Zealand Official cash rate FX swaps
Philippines Overnight repo Repo
Thailand One-day repo Repo
Gradualism and reversion aversion in Asia and the Pacific
Policy rate expectations in yield curves
A deep and liquid bond market:the US Treasury market
Broker DealerDealer
Customers Customers
Interdealer market
How primary dealers provide liquidity
As market makers, they must bid at auctions and provide two-way quotes in secondary market
Unlike in equity market, interdealer market is “informed trading with informed”
To provide liquidity, dealers need informational advantage
Before 1994, trading with New York Fed gave them information about monetary stance
With Fed transparency dealers now make it their business to be well informed about macro developments and how FOMC reads data
They use informational advantage to take large positions in market
Price and trading action when information arrives: the 5-year US Treasury note on employment report day
Price impact of announcement surprises:the 5-year US Treasury note(Fleming and Remolona, JPM 1999)
US announcement Price impact
Non-farm payroll 23.1*
PPI 8.6*
Ten-year note auction 8.0*
30-year bond auction 7.7*
CPI 6.5*
New home sales 5.1*
Fed funds target rate 4.6
Transparency index = 1 – 4.6/23.1 = 0.80
The term structure of announcement effects: the US non-farm payroll announcement
Action is in intermediates -- as market makes guess about policy rate several meetings away
Conclusions
For central banks in Asia and Pacific, monetary policy operations consistent with expectations channel
Policy rate target is short rate
Gradualism and reversal aversion
Expectations reflected in yield curves
In US experience, liquid bond market is one where
Primary dealers provide liquidity when kept well informed about monetary policy
With transparency, yield curves react more to macro news than to policy rate changes
With expectations management, at times of information arrival, action is in intermediate maturities
Thank you!
References
Blinder (2006) “Monetary policy today: sixteen questions and about twelve answers,” paper presented at the Banco de Espana.Fleming and Remolona (1999) “Price formation and liquidity in the US Treasury market: the response to public information,” Journal of Finance (October).Fleming and Remolona (1999) “What moves the bond market,” Journal of Portfolio Management (Summer).Fleming and Remolona (1999) “The term structure of announcement effects,” BIS Working Paper No 71 (June).Ho (2007) “Implementing monetary policy in the 2000s: operating procedures in Asia and beyond,” draft, BIS.Woodford (2005) “Comment on ‘Using the long-term interest rate as a policy instrument’,” (April)Woodford (2005) “Central bank communication and policy effectiveness,” paper presented at Jackson Hole