Via Westpac:
• A quote from last week’s March RBA Board Meeting Minutes, has garnered significant attention over the past week., the RBA noted that: “… Members had a detailed discussion of the Bank’s operations in repurchase and foreign exchange swap markets and their role in achieving the Board’s target for the cash rate.” When we read that comment we did not think it was sending any new message. Our immediate thought was that we should not be particularly surprised that the RBA Board would get an update on the key markets and processes involved in achieving their policy target. Especially when two of the main markets in which they achieve that target have exhibited the volatility and gained the significant market focus we have seen over the past year. In our view, the RBA is most interested in making sure that the cash target is met and that the banks get “home” in their exchange settlement account. What it costs the banks to get themselves funded was not the primary concern of the RBA. That remains our base case in assessing the comment, especially as it was made in the section on financial markets, not the section on monetary policy considerations. However it is clear that the market is talking about it in the context of monetary policy. So some thoughts on that are:
• We should assume that the RBA believe that traditional monetary policy remains effective, at least while the cash target remains above 1%. However there are two considerations currently on the market’s mind. First, the effectiveness of traditional rate cuts is intimately linked to how much of the easing is passed on by the ADI community. So if the RBA can assist in keeping bank funding costs as low as possible, the market is suggesting that the RBA would get more “bang for its buck” in assuring the effectiveness of a decision to renew its easing cycle. Second, given there is a belief that traditional monetary policy is less effective below 1%, what could the RBA do if they needed to add further stimulus beyond that level? That inevitably leads to questions around whether QE would be an option in Australia, and what it would look like?
• Buying of sovereign and semi-government bonds would appear to be out of the question. There is already insufficient high quality, liquid debt outstanding for domestic ADIs to achieve their LCR requirements. So, any traditional QE approaches would severely inhibit the ability of the banks to achieve their regulatory goals and would disrupt the functioning of the asset markets themselves. Would the RBA want to do that? We suspect they would be extremely loathe to do so. Also we would question how they would achieve their goal of ensuring a direct transmission of the full rate cut this way. Maybe over time, if the term risk free rate went to zero or lower, then banks would be able to achieve lower funding costs. But presumably that would take some time to achieve and considering that most mortgages remain variable rate in Australia, the transmission mechanism is not as straightforward as in other markets. It also assumes global investors will be willing to take on AU bank risk at lower yields – unless, of course, the major buyer is the RBA. In our view, the least disruptive solution would be to directly “buy” the banks unsecured mortgages off them. According to the last APRA banking statistics report there are $1.7trn of those outstanding. So that could do the trick, however, if that is what the RBA was looking to signal, their comment would seem a very cryptic way of introducing it.
• Looking at short term funding markets, then, which were the focus of the comment that has sparked discussions, how else could the RBA influence the amount of cash available in repo and fx swaps markets? Do the banks shift a lot more of their funding back to the short end, issuing bank bills that the RBA buys? Perhaps but that would defeat the purpose of the post-GFC regulations which were determined to term out funding maturities, such as the Net Stable Funding Ratio. Of course the RBA could inject more liquidity and reduce costs by simply accepting a lower repo rate when they lend through OMO repos, however they have never previously targeted these rates. Using the Commonwealths FX reserves as collateral through the fx swaps market would help grow the balance sheet along with adopting some of the measures that saw Exchange Settlement balances increase substantially during the GFC although that was driven by the need to provide liquidity and stability under systemic concerns rather than to provide banks funds at cheap rates. If the RBA thought it necessary, a TLTRO style approach would possibly be feasible, however we would have thought the RBA would have framed a move toward that sort of approach in the context of the dramatic fall in housing finance in 2Q2018, not through a “kicking of tyres” on the running of the repo and fx swaps markets.
• The nuances of bank funding costs are very complex, and we do not pretend to have made an exhaustive list of possibilities or options available. While we do not think the RBA is seriously considering QE, the last week’s price action certainly suggest that it is on the market’s mind and we will continue to focus on these issues in coming weeks.
In short, the only real bullet that the RBA has in the chamber is to directly buy (and hold, it is already providing rolling liquidity for such in the CLF) self-securitised mortgages if funding costs get too extreme for banks. That will take crisis.
