The RBA has done well

Via the excellent Damian Boey at Credit Suisse:

As leaked earlier today in the press, the RBA cut the cash rate by 25bps to 0.25%, the effective lower bound. It provided forward guidance to the effect that it will not raise the cash rate until it sees progress on jobs, and inflation back within the band. It also announced plans to purchase bonds out to the 3-year horizon, with a view towards yield curve control (ie keeping rates out to the 3-year horizon fixed at 0.25%).

Presumably, the goals behind the bond purchase program are to:

  1. Limit volatility in fixed income markets, after a recent surge due to risk-parity-related selling of bonds and commodities.
  2. Reinforce  forward guidance that rates will not be increasing over the next few years from 0.25%
  3. Massage down longer-term borrowing costs to the extent that the private sector does borrow at intermediate fixed rate horizons.

However, the problem with announcing yield curve control out to 3 year maturities is that the Bank has implicitly conceded that long-term bond purchases do not work to stimulate anything.

In our view, the RBA has announced measures largely because it said it would do so on Monday morning. There is very little in the announced package that will effectively stimulate activity growth. And nor is it clear that stimulation should be the primary objective, as opposed to ensuring that the system remains liquid and that businesses remain “going concerns” during the COVID-19 shutdown phase.

If stimulation is the goal, we are disappointed that the RBA has not tried to target semi-government bonds to make state government borrowing a risk free exercise, and therefore enable more fiscal spending. We understand that at this juncture, foreign exchange management is an unnecessary objective, given that the currency is undershooting equilibrium by 23% at present. However, it might have been nice to try flooding the system with liquidity anyway, and make things a little more “Chinese”.

In response to the RBA announcement, bond yields out to the 3-year horizon have fallen – but longer-dated bond yields have experienced another sharp leg higher. 10-year government bond yields spiked to nearly 2.5% before receding from their highs – a record sell off. And bond-related equity exposures have not enjoyed the volatility in bond yields either.

We have concerns here about implementation. The RBA said that it will rock up to the market to buy bonds at 11:15am each working day in exactly which segments of the curve it plans to participate in. But the BoJ did the same thing a few years ago, only to discover that bearish bond investors were concentrating their selling around the times the BoJ was not active in the market. As noted in previous updates, it is not entirely clear that the central bank acting as the buyer of last resort really does improve liquidity and reduce volatility in the bond market. Therefore, the key driver of the selling in bonds stopping is simply the improvement of liquidity and volatility due to other factors (eg such as the absence of large scale risk parity selling).

Overall, we feel the RBA would have been better served not doing anything today. That is how effective the stimulus package is likely to be, compared with the cost of lost credibility. And lost credibility is clearly contributing to greater illiquidity and higher volatility, the very things that the RBA should want to avoid.

This is not stimulus, it is basic lender of last resort functioning. The RBA is aiming to stabilise the risk free rate, or the entire system will melt down.

Questions around implimentation are doubtless important but they are secondary to just getting this done. They have the firepower and should use it. The RBA could eat the entire Australian bond market at $600bn without getting indigestion.

More:

Just further to our previous RBA update, in all of the rhetoric around the start of quantitative easing, it is easy to miss the fact that the RBA cut rates, without doing anything special to lower bank “funding” costs (which incidentally have spiked higher). This means that either the banks pass on very little of the 25bps cut, or they pass on a lot, and experience a sizeable margin squeeze.

What officials could have done was to highlight term repo operations to bring down bank bill swap spread to overnight indexed swaps. They might have also considered running a targeted long-term repo operation like the ECB and BoE have in years past.

But at the end of the day, officials did neither of these things. It seems that the purpose in cutting rates all the way to the effective zero bound was to get on with the business of (ineffective) quantitative easing. After all, quantitative easing involves flooding the interbank system with more reserves than it needs, which mechanically drops rates to the zero bound. And considering that the RBA runs an interest rate corridor policy to target the cash rate, the lower bound of zero has now come into view.

There is a school of thought that quantitative easing could be very positive for Australian financials, even if the path to getting there is not very comfortable. We are now going to test out this line of thinking. The reality is that the path to quantitative easing does involve net interest margin pressures on the banks. And we need to remember that desperate measures are put in place because of desperate times. Therefore, investors will face the ongoing temptation to look through stimulus to the underlying bad news driving it.

Where exactly are we along this progression? It is hard to tell. We have only just cut rates effectively to zero. The banks need to respond. We have not yet seen bad debt provisioning rise ahead of businesses shutting down because of COVID-19. And most importantly, credit conditions globally are quite disorderly.

It does not feel like the system is out of the woods yet. If anything we are just walking into them.

I watched the bond market freeze after the RBA announcment. For ten minutes yields barely budged (on my screen anyway). It was a snapshot of monetary failure. We are not out of the woods.

But the RBA has made a good step . The market can’t dump the short end now which should anchor the long to some extent and, if needs be, the bank can shift purchases out the curve. It already said it will buy across durations. Another positive.

The RBA has also anchored bank term funding and the banks won’t be asked to pass any of the cut through variable mortgages. This is about stabilsing the banking system with cheaper funding and expanded margins, not stimulus.

There should be cheaper business lending as well.

This was a good package by the RBA delivered into the most extreme monetary conditions of my lifetime. They are late to the party but have done well now that they are here.

David Llewellyn-Smith
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Comments

  1. After reading “This facility is for at least $90 billion.” I took a breath for the first time this week. It appears now that the RBA is prepared to offer needed support.

  2. Look at the bright side of all the carnage. I bet the carbon emission in 2020 will be materially lower than 2019 or the 2010s average or the 2000s average or even the 1990s average.

    Headlines will read “Coronavirus saved the planet” around this time next year. Who could have known?

    • jonathan grant

      Great point ! When the dollar levels out at the .30 – .40 range we might even be able (will actually have to) to start manufacturing again. Maybe build a renewables manufacturing industry.

      • ErmingtonPlumbingMEMBER

        Just building your own Government vehicles, a prefered Taxi flee vehicle (Toyota camry hybrid), most of your defence hardware and munitions and public transport rolling stock (trains, buses and ferries) makes you a proper Democratic country and indicates your not ruled for the benefit of a bunch plutocrat Fk heads selling out the common people.

        We need people like Sweeper, and Gunna and legends like Rex Connor running this country, not the current crop of toadying sycophants who occupy our parliaments.

        We haven’t had “elected representatives” working for the common good, or those that voted for them, in parliament since 1975.
        The year that started our journey to where we are today.
        https://www.theguardian.com/commentisfree/2014/oct/23/gough-whitlam-1975-coup-ended-australian-independence

        How good was Rex!
        At the 1972 election Labor came to power under Gough Whitlam, and Connor was elected to the front-bench and appointed Minister for Minerals and Energy. In this portfolio he sought to develop an Australian-controlled mining and energy sector, one not controlled by the mining companies he disliked. Among his plans were a national energy grid and a gas pipe-line across Australia from the North-West Shelf gasfields to the cities of the south-east. He liked to recite a piece of poetry by Sam Walter Foss (who was, ironically, American):

        “Give me men to match my mountains,
        Give me men to match my plains,
        Men with freedom in their visions
        And creation in their veins.”

        https://en.wikipedia.org/wiki/Rex_Connor

    • bolstroodMEMBER

      You of all people should be aware of the the force on the dark side.
      As the economies stop and the air clears, the planet will experience a 0.5 degree C increase in global tempreture.
      The petro-chemical pollution in the upper atmosphere has been acting as a heat shield., and will disipate when not renewed

    • I was going to point that out the other day. The Greens will be ecstatic – added to which ScroteMo will have condemned half his voter base to death. Greens to win the next election? (subject to hipsters shaving their fcken beards and avoiding the worst of the virus).

  3. jonathan grant

    Ah he’s got his excellent tag back. Not sure why. He seems to think like an AI bot not capable of thinking outside his mathematical models. I’ve got to think the banking system is hurtling towards failure. Thanks David for the most sober explanations I’ve found anywhere. I’m gonna subscribe now that I’ve got some money. Shorting the AUD has been pretty pretty good recently.

  4. 5000 years of recorded civilisation and we are at lowest rates of that time as i understand it (even lower than great depression and WW2)…….what comes next……euthanise the saver is occurring…..does war come next….if so who and when……2020’s???

    • Jumping jack flash

      It really depends on what happens next.

      They wanted QE, now they finally have it. We now wait a moment to bask in the glory of having QE, and for it to resolve all the problems with the economy.

      It all hinges on the interest of the debt being repaid. It doesn’t really mater how it is repaid, but so long as it is repaid that is the only thing that matters: The government could step in and repay the interest, or new factories could spring up and start making useful items to sell to the world to earn money to repay the interest, or debt could be made cheaper so people will finally borrow the cheap debt to repay the interest.

      • No they won’t! Expertise and drive is lost. Local chains are gone… there is beyond *fvck all* to support it. This *spring* thing may be a multi decade endeavor, for which the conditions have to be right at least for the first 20 years.

        • The Traveling Wilbur

          Pessimist.

          If the AUD gets to .30 we could start a passenger car manufacturing industry here. Merge all that still viable Ford and Holden IP together while we still can find some of it!

          Folden Australia.
          Obviously.

        • Jumping jack flash

          Oh for sure. I was being a bit facetious. Of course the option they chose is #3, creating additional debt which requires interest to be repaid on it, to repay the interest on the previous pile of debt.

          As we see with the move to QE today, they are serious about getting more debt out there and into the hands of the people.

    • Strange you should ask – I was just consulting my crystal ball and I can confirm this is basically the end of the road for the existing monetary system. And not before time.

  5. ” This is about stabilsing the banking system with cheaper funding and expanded margins, not stimulus.”

    So the banks can absorb the bad loans, by continuing to r4pe the people who somehow manage to keep their jobs

    Helicopter money was what was needed

  6. “The RBA could eat the entire Australian bond market at $600bn without getting indigestion” Maybe now, but won’t it be getting a whole bigger very quickly??

  7. This isn’t good policy. It’s too focused on the banks and not the economy.
    Paying interest on reserves is incredibly stupid.
    The bond market is signalling a scramble for cash. That requires helicopter money directly to households and corporates. Not a swap of safe assets for cash with the banks and then paying them money to have it sit there doing nothing.
    They can’t afford to do that here where there isn’t a major short term funding market outside the banks.

    • Concur Sweeper its much as Hudson has said, about covering the protected species so they can renew lording over the unwashed post the pain they caused in the first place.

    • Of course they were going to look after the banks, house prices to the moon on NINJA loans and low interest rates while the real economy crumbles into ruin, same as they have done since the last crisis !

          • Jumping jack flash

            Payments? A couple of gigs a week will be enough soon. The bank makes their money back when the asset is sold for double the cost after 7-10 years of debt inflation.

            The problem for many is the debt ponzi buy-in cost of minimum 5% of the purchase price. That’s the killer.

      • Jumping jack flash

        Yes. 100%
        Their problem isn’t the cost of the debt anymore, it is the eligibility of the people to take advantage of cheapest debt.

        The banks’ archaic rules around debt eligibility just reinforces the fact that they really don’t believe in their own system for infinite debt, and infinite riches for all. Their archaic rules are severely limiting the growth of debt, and therefore the growth of the economy.

        Debt is completely essential and it is completely impossible to be able to obtain the things we need without requiring enormous quantities of debt. It is a travesty that debt is still so hard to get, despite there being absolutely no risk.

  8. As in the US, the RBA needs to get its hands on the most pristine collateral it can in the shortest time possible, these are first steps towards this, hopefully the AOFM will finally issue some 3 year bonds that the market has been screaming for, for a couple of years…….this is a collateral problem of magnificent proportions and their balance sheet needs to grow quickly.

    https://alhambrapartners.com/2020/03/18/moreon-collateral/

    The payments on the exchange settlement balances are disappointing but to be expected.

    • I don’t think it is a collateral or credit problem. And if it was the RBA is now taking quality collateral out of the market.
      It looks like a financial panic or scramble for cash. If they get the cash out the bond rates will stabilise.
      During the panic stage of GFC the Fed swapped its Treasuries for weaker collateral and got cash out to non-financials through its commercial paper facility. This is different. And paying interest on reserves is terrible policy.

      • Of course it is a scramble for cash at the moment as you say but at some point there will hopefully be a resolution of these problems which will not be solved by cash balances.

        The market is failing and the RBA will be taking over for a while…….it has all the cash it wants any time it wants……other people may create cash equivalents but only the RBA can turn them into cash. It doesn’t have all the safe assets it wants to restructure things in future.

        Whatever they do I hope they let the bad debt be written off, then the market might re-invent itself but if they prop up all the bad debt it will have all been for nothing again.

        • Jumping jack flash

          Governments can create real cash with the printing presses, but they hand it all over to the banks to sell as debt. This contains the hyperinflation which would otherwise occur.

          Of course there’s a cash problem because nonproductive debt doesn’t contribute anything to the economy, it just extracts money out as interest that needs to be paid back to the bank for using their debt.

  9. With all due respect, the RBA is pressing buttons and pitching left and right in the cockpit of a plane that’s just lost both its wings and is falling out of the sky.

    The real economic consequences of this global catastrophe are ahead of us. When the plane meets the Earth.

  10. Ok silly question I’m sure but if funding costs are still high should the banks not offer some slightly higher interest rates for depositors to attract capital.

  11. Well, here comes the housing bail out effort:
    Government working to prevent mortgage foreclosures
    Prime Minister Scott Morrison has said he is working with the banks to prevent the foreclosure of people’s mortgages. “That’s exactly what we’re working on. That’s what’s cushioning the blow is all about,” Mr Morrison said.
    But if the narrative on the SME bail out is anything to go by..
    Asked why a business would take out a loan if it has lost all of its income, Prime Minister Scott Morrison pointed to the government’s other measures such as grants to small business and income support.
    “That’s not going to cover all the bills, we understand that, but it is going to go some way to provide some assistance,” Mr Morrison said.

      • I watched the speech live and my favourite part was this “There is no extra borrowing allowance for additional housing loans.”
        For every extra dollar lent to large business, lenders will have access to an additional dollar of funding from the Reserve Bank. For every extra dollar of loans to small and medium-sized businesses they will have access to an additional five dollars. These funds can be drawn upon up until the end of March next year. There is no extra borrowing allowance for additional housing loans.

      • Guys guys guys. You think this is about people? It’s about the banks. If the banks depend on IP mortgages, they also get bailed out. Or try to anyway.

        • Yes, the IPs are a weak but key link here – let them go and all else gets dragged down with it. I still don’t think the Gubmint has a cat in hell’s chance of keeping it propped up but they’ll try no doubt.

          • Death by a thousand cuts it will be.. reckon the housing thing will be another Tax write off or something else that won’t actually put money in their pocket.. govt is trying to make the cost of debt less when the issue is an income and cashflow problem..
            I think by the time they figure out that households just needed 10k in the bank and yes, that’s 10 x the krudd solution, it will be too late.

  12. The RBA has performed precisely as anticipated.

    It has announced policies that are designed to support the privatisation of the public money power.

    All the quibbling about whether the policies and actions are the best choices miss the point that the first priority is that any policies do not undermine the primacy of the private banks at the core of the monetary system.

    But don’t worry, Josh made it quite clear that banks lurve their customers truly, madly, deeply.

  13. Jumping jack flash

    The question remains whether people will take the bait.
    Considering this is a stability exercise then maybe they don’t care for now, but the fact is that the 2 trillion nonproductive mortgage debt dollars still need about 100 billion dollars or more to repay their interest each and every year the debt exists.

    This 100 billion dollars must mostly be repaid from new debt in order for it not to suck too much productive money from the economy, ultimately shrinking it.

    Will these measures be enough to create enough debt? This is the actual question.

    • You keep saying this but I don’t think it’s true

      The interest payments are recycled back into the economy by bank dividends and wages

      The problem is distressed sales reducing the “value” of the collateral (houses)

      • Jumping jack flash

        “The interest payments are recycled back into the economy by bank dividends and wages”
        The whole 100 billion? Every year?
        Seriously doubt it.
        A good proportion of the interest receipts the banks don’t even own.

    • My bloke is in the uk. It’s been hard to persuade him to take it seriously.
      Gets on the plane early tomorrow morning our time, into Tullamarine early Sunday morning.
      Luckily an Australian citizen, au passport.
      I nearly had a heart attack when I read borders closed.
      I thought he’d missed it.
      My sons friend is in Malaysia via a Monash course. She is now in Malaysia for the foreseeable future, as no planes in or out( and apparently no warning from Monash).
      Too late for her by the time the DFAT warning came.

      • My sister is in Dubai on her way to South Africa then Botswana. I wanted her to come back here. But I actually think Botswana may do better than here. If she can get in before borders all shut.

        • Good luck for your sister( and everyone else).
          Hopefully Rob steps off that plane Sunday morning- I’ll believe it when his feet hit Australian soil.

      • My better half is in uk heading home today , was only there to see terminally ill parent.

        Emirates who code share with qantas wouldn’t allow them to rebook as was booked with sky scanner online , so had to pay nearly 2000 GBP for one way ticket home.

        I feel sick knowing we all will have bail the same opportunistic cntys

  14. What the RBA and CB’s/Sovereigns have announced over the last couple of weeks is that nobody, anywhere, will have to accept any losses, on anything, ever again!

    lolz

    • Ah, the bailout culture, alive and well – immortalised in the GFC debacle, it’s become quite the thing. So many important people, so many important businesses, critical to the very survival of mankind. Bail them ALL out!!

      We are doomed. Let it all burn.

  15. Genuine and naivve question to all Macrobusiness experts:
    What is the best course of action a saver (say someone with 100K savings in the bank) should do now to protect themselves? Buy physical gold? Buy Perth Mint unallocated gold? Buy a good safe, withdraw all the saving and keep in the safe? Distribute among several savings accounts in different banks? Any Vanguard (or similar) alternative to cash index fund? Saviings in USD in an international bank (like HSBS bank)?

    • Tough call. But being in cash right now means you’ve avoided being wiped out in the stock market – big plus. Those with cash at the bottom of the bear market will be the only ones liquid enough to hoover up some seriously cheap bargains.

      In terms of safety, I think your cash is safe in the bank but if you feel nervous buy a short-dated Govt T-bill. I think they’re listed on the stock exchange. Easy as.

      The real danger being in cash is the purchasing power but one way to look at it is that you’ll be compensated down the line by having access to cheap stocks – so it’s not all doom. If you think the financial system is at risk and that hyper-inflation is a possibility I’d definitely wave in some gold. Perth Mint, not a bad option but you do have counterparty risk and political risk (if hyperinflation ensues, the Gummint will waste no time in helping itself to the unallocated gold at the Mint and any other they can lay their hands on). Alternatively buy some bullion and bury it in your yard (if appropriate) – then discover the Greek in you and pave over the loot – not ideal, I concede, especially if you need to escape in the dead of night. 😉

      In a perfect world, you’d have 50k-100k in the bank here for general liquidity, 250k+ of gold in a private vault in Switzerland and your Super almost entirely in cash at the moment. No easy answers but hope this helps.

  16. robert2013MEMBER

    QE is welfare for financiers. Nationalise the banks instead. Roll them all into the RBA and give everyone an account there. But I forget. This is Australia where we only copy policies implemented elsewhere first, enabling us to reassure ourselves that we are “world class”.

    • Possibly. But also you had traders frontrunning the QE announcement – once it was announced (cast in stone) the shorts took profits thus driving the poo back up again. Once news is ‘in the market’ there are no surprises – it’s priced in. Thus:

      Buy the rumour, sell the fact ..

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