Vigilante Justice

Predictably, media coverage of the RBA’s Tuesday policy tweak was replete with nonsense.

One particularly inane headline read, “Bond Tsunami Forces Australian Policy Switch in Lesson for World.” The first line is: “Bond market one, central banks zero.”

Even if you’re inclined to believe traders are capable of “winning” a fight against an authority armed with a printing press, the journalists responsible for the linked article apparently didn’t start keeping score until last week. I’m not sure what the tally is in the contest between central banks and bond vigilantes if you assume the game started in 2009, but suffice to say it’s a blowout. And the vigilantes are behind.

On Tuesday, the RBA left the policy rate unchanged and said they’ll keep buying bonds at $4 billion per week until mid-February, but abandoned the 0.1% cap on the April 2024 note after declining to defend the level last week, when it rose to eight times the target (figure below).

To recap, the problem started in earnest last Wednesday, when a hot quarterly inflation print reinforced expectations for rate hikes far sooner than Philip Lowe’s timeline. Then, on Thursday, things escalated into what one outlet called “mayhem.” On Friday, when the RBA again declined to step in, it was obvious the target would be dropped at this week’s meeting.

“The decision to discontinue the yield target reflects the improvement in the economy and the earlier-than-expected progress towards the inflation target,” Lowe said Tuesday. “Given that other market interest rates have moved in response to the increased likelihood of higher inflation and lower unemployment, the effectiveness of the yield target in holding down the general structure of interest rates in Australia has diminished.”

Three-year yields in Australia rose the most since 1994 last month.

What is remarkable about this situation is the abruptness with which the target was jettisoned. Two Fridays ago, the RBA was still defending it. So, market participants will be forgiven for using words like “forced.”

That said, it’s critical to acknowledge the self-evident: Notwithstanding the temptation to generate web traffic with headlines suggesting the vigilantes of yore scored a victory against monetary authorities, this is everywhere and always a question of i) will, and ii) credibility. It’s never a question of capacity, or at least not when considered in a vacuum, where the side effects of being obstinate for the sake of it are ignored.

More simply: Central banks can defend whatever arbitrary line in the sand they want to defend for as long as they want to defend it because their capacity to conjure firepower is unlimited. The RBA didn’t “lose.” They just decided that, considering the message from semi-administered markets (versus the YCC note, which was strictly administered), the target risked becoming an anachronism — an oddity with no purpose other than to serve as a reminder that monetary authorities can render terms like “market prices” meaningless. A decade on from Lehman, markets scarcely need such reminders.

The first linked article (above, from Bloomberg) buried the lede. The important takeaway from the RBA’s experience is that sooner or later, outcome-based forward guidance can’t peacefully coexist with front-end targeting, assuming the economy makes progress towards the stated outcomes.

Relatedly, you could argue that in hindsight, the RBA’s emergency policy regime was convoluted, redundant, or both, which means the effort to dismantle it could become a comedy of errors.

For instance, one analyst at Oanda on Tuesday said the bank is now in “no man’s land,” by retaining QE and a relatively dovish policy bent, but scrapping YCC. “The RBA are trying to hedge their bets and have got the worst of both worlds,” the analyst, Jeffrey Halley, remarked. “The market will take them up on in this.”

Lowe skewed dovish. The RBA is “committed to maintaining highly supportive monetary conditions,” he said, adding that although inflation “has picked up, it remains low in underlying terms.” Price pressures, he insisted, “are also less than they are in many other countries, not least because of the only modest wages growth in Australia.”

Crucially, Lowe didn’t confirm aggressive market pricing for rate hikes. In fact, he was a semblance of stubborn in a webinar following the policy decision. “I want to make it clear that this decision does not reflect a view that the cash rate will be increased before 2024,” he said, adding that, “there is genuine uncertainty as to the timing of future adjustments in the cash rate [and] given the information we currently have to hand, it is still entirely possible that the cash rate will remain at its current level until 2024.”

That dovishness could ultimately anchor the Aussie front-end, an ironic outcome considering the decision to ditch the target on the YCC note.

“The scrapping of the YCC target on the basis of economic improvement but the push-back on rate hikes is likely to dampen front-end yields since this manages to tame the more aggressive 2022 rate-hike bets,” Mizuho’s Vishnu Varathan remarked. “The more aggressive bets on RBA being ‘forced’ to change its stance to acknowledge rate hikes sooner has been knocked back insofar that the RBA has pretty much quashed bets that it will react to the current inflationary overshoot.” Do note that the scare quotes around the word “forced” were in the original.

Lowe couldn’t have been any clearer. “On the issue of timing, the latest data and forecasts do not warrant an increase in the cash rate in 2022,” he said. “I recognize that some other central banks are raising rates, but our situation is different.”

That’s a direct rebuke of market pricing around rates.

Another reporter on Tuesday suggested the RBA gave “a nod to the power of the bond market.” Forgive me, but no, they didn’t.

Instead, Lowe threw the bond market some scraps. He had the policy rate, QE and an increasingly asinine target for a specific note. He brushed the latter from the table like so many crumbs from a dinner napkin. Vigilantes-turned dogs licked them up and called that a “win.”

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3 thoughts on “Vigilante Justice

  1. I’m happy to cut the Aussie vigilantes some slack in contrast to their American counterpartsm who are content to buy every dip, then don their desert camo and head to the Target parking lot to do some open-carrying protesting against pandemic management, road repairs, and other insidious forns of freedom-killing socialism.

  2. It seems that bond markets resemble a pet chasing their tails. At least for now. The idea that central banks would raise rates in response to the financial markets is silly at this point. Sometimes financial market moves must be dealt with by central banks- for instance if lending markets shut, if markets become so unglued such as UST bonds in March 2020, a financial market panic/crash- that central banks need to act as lender of last resort. But not to raise or lower a short term rate in response to a market move anticipating such a raise or cut. The central banks rightly target employment, income, inflation and the soundness and integrity of the banking system. As long as markets function to some degree, they can safely keep a watchful eye but not react to every squiggle in market moves.

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