RBA drops deflationary AUD-bomb on economy

See the latest Australian dollar analysis here:

Macro Afternoon

As the Australian dollar’s unruly melt-up continues let’s revisit what the RBA said yesterday:

At its meeting today, the Board decided to maintain the current policy settings, including the targets for the cash rate and the yield on 3-year Australian Government bonds of 25 basis points.

The global economy is experiencing a severe downturn as countries seek to contain the coronavirus. Many people have lost their jobs and there has been a sharp rise in unemployment. Over the past month, infection rates have declined in many countries and there has been some easing of restrictions on activity. If this continues, a recovery in the global economy will get under way, supported by both the large fiscal packages and the significant easing in monetary policies.

Globally, conditions in financial markets have continued to improve, although conditions in some markets remain fragile. Volatility has declined and credit markets have progressively opened to more firms. Bond rates remain at historically low levels.

In Australia, the government bond markets are operating effectively and the yield on 3-year Australian Government Securities (AGS) is at the target of around 25 basis points. Given these developments, the Bank has purchased government bonds on only one occasion since the previous Board meeting, with total purchases to date of around $50 billion. The Bank is prepared to scale-up its bond purchases again and will do whatever is necessary to ensure bond markets remain functional and to achieve the yield target for 3-year AGS. The target will remain in place until progress is being made towards the goals for full employment and inflation.

The Bank’s market operations are continuing to support a high level of liquidity in the Australian financial system. Authorised deposit-taking institutions are making use of the Term Funding Facility, with total drawings to date of around $6 billion. Further use of this facility is expected over coming months.

The Australian economy is going through a very difficult period and is experiencing the biggest economic contraction since the 1930s. In April, total hours worked declined by an unprecedented 9 per cent and more than 600,000 people lost their jobs, with many more people working zero hours. Household spending weakened very considerably and investment plans are being deferred or cancelled.

Notwithstanding these developments, it is possible that the depth of the downturn will be less than earlier expected. The rate of new infections has declined significantly and some restrictions have been eased earlier than was previously thought likely. And there are signs that hours worked stabilised in early May, after the earlier very sharp decline. There has also been a pick-up in some forms of consumer spending.

However, the outlook, including the nature and speed of the expected recovery, remains highly uncertain and the pandemic is likely to have long-lasting effects on the economy. In the period immediately ahead, much will depend on the confidence that people and businesses have about the health situation and their own finances.

The substantial, coordinated and unprecedented easing of fiscal and monetary policy in Australia is helping the economy through this difficult period. It is likely that this fiscal and monetary support will be required for some time.

The Board is committed to do what it can to support jobs, incomes and businesses and to make sure that Australia is well placed for the recovery. Its actions are keeping funding costs low and supporting the supply of credit to households and businesses. This accommodative approach will be maintained as long as it is required. The Board will not increase the cash rate target until progress is being made towards full employment and it is confident that inflation will be sustainably within the 2–3 per cent target band.

Having finally gotten to QE a decade too late, the RBA has refused to use it and it now sees rates only going up from here. Added to that it is demanding fiscal and plying the airwaves with its usual positive thinking tripe.

Once again, the decade-behind RBA has brought a spoon to the currency gunfight. More at Bloomie:

The central bank’s reluctance to contemplate life below zero is helping set it apart from developed-market peers, drawing the likes of PGIM Inc. and JPMorgan Asset Management to the $482 billion sovereign bond market. Australia’s 10-year bond yield discount to Treasuries flipped to a premium in March as the Federal Reserve slashed borrowing costs, spurring bets U.S. rates would turn negative next year.

Australian bonds are “competitively well supported and they represent a good storehouse of value that requires less of a leap of faith than most developed markets” to invest in right now, said Robert Tipp, head of global bonds and chief investment strategist at PGIM Fixed Income, which oversees $868 billion. Investors should consider going “long Australia on a core basis.”

A gauge of Australian bonds is the best-performing among Group-of-10 peer equivalents, showing a 9% total return for the second quarter to June 1, according to Bloomberg Barclays indexes.

Anchoring demand for Australian bonds is the RBA’s pledge to maintain benchmark three-year yields at the 0.25% cash rate. That’s in stark contrast to regional neighbors New Zealand, where the central bank is openly discussing the possibility of negative rates and Japan where they have been below zero since 2016.

“QE measures and the RBA’s posturing on negative rates are helping to keep yields positive and that could be attractive for some,” said Raymond Lee, a money manager at Kapstream Capital who is long three-year Aussie bonds as a hedge for riskier credit bets. “Australia has a yield advantage compared to places like New Zealand which is open to the idea of negative rates, or even the U.S. where the Fed is keeping yields low.”

If it does not change direction or add to its kit bag soon, and iron ore remains strong (which will do virtually nothing for domestic demand), the RBA will annihilate Australian inflation with a currency a-bomb:

David Llewellyn-Smith
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