Bank of Canada staff discuss replacing all federal debt issues with 3 fungible perpetual bonds paying fixed, floating, and inflation-linked rates

by kiwimancy

Main paper: www.bankofcanada.ca/wp-content/uploads/2018/12/sdp2018-15.pdf
Mentioned in money stuff: www.bloomberg.com/opinion/articles/2018-12-11/a-happy-anniversary-for-madoff-s-scam

The paper discusses four ways of improving liquidity of canadian government bonds which should lower the cost of their debt. The last of these is pretty interesting, proposing that they would buy back the currently outstanding bonds which have many different maturities and rates and aren’t easily interchangeable and issue three types of perpetual bonds in their place. One has a single fixed rate, one has a floating rate, and the third is inflation-linked.

The government could expand and contract their debt, or change up its rate structure, by issuing and buying these bonds at any time rather than at intermittent auctions. They would be fungible within each class – a perpetual fixed rate bond issued in 2018 is identical to one issued in 2019 – so the market will be more liquid, lowering the yield.

It has a few other implications: For one, the government and investors can construct any fixed maturity or duration they want from these basic bond types. However it might be inconvenient for retail investors to do this. A new market of intermediaries would pop up to construct them for clients.

For another, it dispenses with the illusion that government debt is something that is meant to be payed off. Governments like to use debt and investors like to own it.

 

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Elsewhere in central bank discussions: US Federal Funds volume is drying up and the Fed discussed in november whether to change their target to perhaps OBFR (which adds overnight bank borrowing from non-banks like money market funds) or the recently defined SOFR (repo market rate introduced to supplant LIBOR).

www.bloomberg.com/news/articles/2018-12-11/the-death-of-fed-funds-as-market-dries-up-fomc-asks-what-next

 

It’s mostly theoretical I think rather than a real proposal. But as an investor you would no longer be able to buy canadian government 5 yr bonds for example, only bonds that never mature. You would still have 5yr bank GICs and you could buy a 5yr canadian government bond ETF or something that holds a particular mix of floating and fixed rate perpetual bonds that mimics a 5yr maturity.

 

 

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