Research Department Analysis : The effect of the Bank of Israel’s intervention in the government bond market

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    In the beginning of the health crisis that hit Israel and the rest of the world, there were massive withdrawals in Israel’s capital market from government bond funds at institutional investors’ funds in general, and at mutual funds in particular.

 

·         In that situation, temporary “price pressures” developed, as market participants required a premium to buy the government bonds. Evidence of this can be seen in the gradual reversal of prices to the levels of early March toward the end of the month.

 

·         Using daily mutual fund data as an estimate for these flows indicates that not all of the transitory increase in yields can be attributed to the price pressures of the government bond mutual funds or to the change in yields abroad, and that it probably also derived from other frictions in this market and/or from changes in information regarding the state of the economy and risk premiums.

 

·         It is reasonable to assume that the Bank of Israel lowered the premium to investors who wanted to sell the bonds in the market by effectively becoming a liquidity provider in the secondary market.

 

·         The Bank of Israel’s main impact on yields was at the time of the announcement on March 23 of its undertaking to purchase NIS 50 billion of government bonds. High frequency analysis shows that yields on the 10-year government bond have decreased by about 11 basis points right after the Bank of Israel's main announcement. This outcome is consistent with an examination conducted at the Bank regarding the Bank of Israel’s intervention in the government bond market in 2009.

 

·         Indirectly, the Bank of Israel apparently also reduced the costs of issuing government bonds, companies’ costs of issuing corporate bonds, and households’ costs of raising funds during that period.

 

 

Background

 

The Bank of Israel works to maintain the stability and proper functioning of the financial system. During the course of the coronavirus crisis, the Bank adopted several policy measures to ensure the proper functioning of the financial markets, to deal with liquidity difficulties that adversely impacted the financial system, to ease the terms of credit in the economy, and to support economic activity and financial stability. As part of this, the Bank acted through several channels, beyond reducing the interest rate to its historically lowest level—injecting liquidity into the bond market through repo transactions with bonds as the security, supporting the foreign exchange market via NIS/$ swaps, assisting with increasing the supply of credit to small and micro businesses by extending designated loans to the banking system, and reducing credit costs in the economy via the purchase of government bonds, as will be described in further detail in this document. The Bank of Israel constantly examines the effect of the steps and continues to follow the developments, and will use additional tools to the extent necessary in order to continue supporting economic activity.

 

From the beginning of the health and economic crisis that occurred at first abroad and then in Israel, massive withdrawals were seen in March from government bond mutual funds, which at times serve as a safe haven for investors, at institutional investors[1] in general and the mutual funds in particular (Figures 1, 2 and 3).



[1] These data do not include the insurance companies, banks, and hedge funds for which we do not have data.