If the US has ‘operation twist’, then should Australia have ‘operation reverse twist’?
The US Federal Reserve is trying to twist the US treasury yield curve in a clockwise direction. In ‘operation twist’ it is rebalancing its holding of US Treasury securities — selling short term treasury bills to free up funds to buy longer term treasury notes and bonds. The Fed’s intention is to flatten the $US treasury yield curve. In particular, the Fed wants to decrease the yield on longer term treasuries by increasing demand for those notes and bonds. The Fed reasons that most borrowing by US households for housing (mortgages) and by US corporations for investment (corporate bonds) is long term and fixed rate, so that borrowing is benchmarked against long term US treasuries. If the Fed can bring down the yield on long term US treasuries, by buying long term notes and bonds, then the interest rates in the mortgage market and the corporate bond market will fall correspondingly, which will induce increased investment in housing and corporate projects.
Australia’s situation is very different. Far from having a yield curve that is too steep, Australia’s yield curve is inverted, meaning that short term treasury yields are higher than longer term yields. The RBA’s Cash Rate (the overnight interest rate) is 3.50% and the yield on 3 year $A treasury notes is 2.50%. That is not the only difference. Australian mortgages and commercial bank loans are mostly floating interest rate. Therefore, the interest rates faced by Australian households in the mortgage market and Australian firms in the corporate borrowing market move up and down with the short end of the yield curve (cash rate and 90 day bank bill swap rate), not the long end, as they do in the US. Lower short term rates, not long term rates, are needed to stimulate investment in Australia.
Australia’s situation is the opposite to that of the US: Australia’s yield curve is too shallow, not too steep, and investment is driven by short term rates, not long term rates. So, does it follow that Australia should have the opposite strategy to the US? Should the Australian Treasury issue three year notes at 2.50% and use the proceeds to buy 90 day bank bills at 3.60%? Why the Treasury and not the Reserve Bank of Australia? Because the RBA doesn’t hold a lot of $A treasury bills that it could sell to buy $A treasury notes. In fact there are only a few billion of $A treasury bills, and the RBA does not hold much Australian Treasury debt of any kind.