RBA's Debelle Says Decline in Bond Market Liquidity Here to Stay

  • China's bid to support yuan likely affecting long-term yields
  • Slowing Aussie population may mean lower potential growth rate

Bond market participants will have to adjust their behavior to cope with a decline in liquidity, Reserve Bank of Australia Assistant Governor Guy Debelle said.

Debelle, who oversees markets at the Australian central bank, said it’s unclear whether the changed market conditions are “more conducive to temporary flash crashes or permanent dislocations.”

Permanent market dislocation “is of significantly greater concern” than a temporary crash, “which can be avoided by a well-timed coffee break,” he said in the text of a speech in Sydney.

Regulators are seeking to ensure that post-crisis rules and monetary policy aren’t creating a toxic brew that will explode amid a sudden exit by investors. Warnings have intensified as the Federal Reserve prepares to increase interest rates for the first time in almost a decade, the beginning of the end to an unprecedented era of stimulus that pushed $1.1 trillion of investor cash into the bond market, according to data from the
Investment Company Institute.

Debelle said China’s efforts to support its currency by running down foreign reserves probably comprises some sales of U.S. treasuries and other sovereign bonds due to their liquidity and are in turn affecting global long-term yields.

“We are seeing an unusual situation where a risk-off environment is associated with sales of the risk-free assets by a large market participant, rather than purchases,” Debelle said.

Turning to Australia, Debelle highlighted the recent slowdown in population growth, meaning there are “some grounds to believe” the economy’s medium-term growth rate has slowed.

“But the orders of magnitude we are talking about are pretty small, of the order of a quarter of a percent,” he said. “That is well within the range of error around our knowledge of the longer term growth rate of the economy. That said, I realize a quarter of a percentage point can matter a lot actuarially when compounded over a number of years.”

While the government bond yield is the best measure of the risk-free yield in the economy, Debelle said “there are some reasons to believe that is now structurally lower than it used to be.”

However, he said that any proposition that economic growth, and therefore risk-free yields, will be lower than in the past due to slower rates of innovation and technical progress was “too pessimistic.”