Does the Yield curve contain useful information for the Reserve Bank?
Last Modified Date:
2020-10-01, 09:35 PM
Speeches > Speeches by Governors
Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Annual Convention of the Actuarial Society of South Africa, Midrand. IntroductionFederal Reserve chairman Alan Greenspan once famously told a congressman that if what he had said was clear, the congressman must have misunderstood him. Central bankers are always looking into an uncertain future; that is why they are sometimes less direct than the public might want them to be.As the Governor of the Reserve Bank, it is my job to worry about the future even while things are going well in the present. It is the same for central bankers all over the world; the Bank of England and the United States Federal Reserve recently reminded us of the need for pre-emptive action by tightening policy before the actual inflation numbers started to gain momentum.It is this preoccupation with an uncertain future which explains why the word "signal" crops up so often in the language of monetary policy. One only has to read the financial papers to be struck by how often the word is used in the context of central banking. Monetary policymakers are constantly watching for early warning signals on the economy, and from time to time we, in turn, give signals to the markets and the public on monetary policy.What, then, are the signals that the Reserve Bank watches for from the markets and the economy? The answer to that question would fill quite a few dissertations, and, therefore, cannot be spelled out in detail. Central bankers cannot be too direct, as I have already said. We also have to bear in mind that, because the South African Reserve Bank is still in the process of establishing an inflation-targeting framework, the importance attached to various signals is under serious review.The inflation-targeting framework will not really simplify the range of variables and events deemed to be relevant that much. In the new framework, we would be able to analyse variables and events incorporated in the inflation-targeting models as well as variables and events not explicitly incorporated in the inflation-targeting models, such as bad debts in the banking industry, but which are also important for the maintenance of financial stability. In this regard, we have been watching the effects of the liquidation of Macmed with interest.For today, given that my audience is concerned with long-term investment portfolios, I shall discuss an issue which appears to be something of a favourite topic among South Africa’s investment analysts — the term structure of interest rates, or the yield curve.The market determines different yields on investments of different maturities; of considerable importance is the gap between interest rates on short-dated investments and those with longer maturities. If these interest rates are plotted against unexpired maturity, the result is the yield curve, and of importance is its slope.Does the slope of the yield curve provide the Reserve Bank and the investment community with useful information?Before discussing the issue, it is worth noting that there are many good reasons to take into account signals from the financial markets in reaching monetary policy decisions. For one thing, market prices are up to date, and policymakers therefore do not face the problem that they do with other economic data. Information on the real economy only becomes available after a time lag, and it is possible that by the time enough information has been acquired on, say, trends in capacity utilisation or unit labour costs to make it clear what course of action is necessary, it might be very late in the day. In addition, it seems that some indicators that are relatively current, such as the monetary aggregates, are not sufficient by themselves as early warning signals of inflation.The most obvious way in which the yield curve can assist the Reserve Bank is in providing information on inflation expectations. But, as I shall argue, the message from the yield curve is not unambiguous in this respect. I shall discuss the issue in general terms first, before mentioning recent devel