Via Nikko:
For the past six months, the RBA has been subdued at using unconventional policy compared to offshore. After six months of sitting on the sidelines, the RBA has finally eased rates.
Chris Rands, Portfolio Manager, Fixed Income at Nikko Asset Management has penned a piece exploring the RBA’s delay to move and ease rates, deep diving on what elements shifted their thinking through a series of pertinent questions and answers. You can view the full paper, here.
The RBA mentioned the cash rate was unlikely to increase for at least 3 years, however, Chris makes a compelling argument that the cash rate will remain below 1% for 5+ years. And if it is anything like the US after the GFC, this should see the cash rate remain at the zero lower bound for 5 – 7 years.
Chris explores four tough questions for the RBA. The commentary from the RBA really helps clarify why they are now shifting to a position of additional easing, which can be summed up by four ideas:
Monetary policy should be more effective now businesses are reopening.
The recovery of the economy will be extremely uneven and some sectors will require significant support.
The usual arguments around financial stability are not particularly relevant at this time.
Everyone else is doing it.
You can also find key soundbites for each of the points outlined in the paper, below:
What was the RBA waiting for?
Two reasons why the RBA should have been doing more:“Typically in a recession central banks cut rates 400 to 600 basis points (currently the RBA has cut 100 – 200 bps).”
“Central bank research from offshore confirms that quantitative easing (QE) works.”
“As the economy opens up, the RBA believes that easier rates will have more traction. This makes a lot of sense intuitively, since businesses probably didn’t need a lot of credit when they were operating at a reduced capacity with significant government support.”
“This is even more obvious from a personal credit perspective, with the RBA showing credit growth in the personal sector worse than the GFC. Any effect from further rate cuts over the past six months would have been muted for personal borrowers.”
“The key take away is that the RBA still believes monetary policy and quantitative easing work. They were just waiting for the opportune time to deploy it.”
Why wait until the outlook was improving?
“Why do the RBA cut rates now, given economic forecasts are looking better? Unemployment likely won’t spike as high as originally expected, Victoria has just reopened, retail sales have been relatively strong and the worst of it (hopefully) seems to be behind us.”
“The reason to add more support in light of this is due to how “uneven” the recovery of the economy will be. Some sectors will likely perform well, while others remain in an extremely tough situation.”
“One obvious place to look for evidence of an uneven recession is the effect on businesses in Australia. Some businesses have come through the COVID-19 crisis unscathed, while others remain in a perilous position.”
“JobKeeper and JobSeeker are reducing; default moratorium has ended, those with deferred loans will need toroll them over. In 3-6 months time, all of these support could be gone. The flow-on effect from this is obvious: if conditions don’t improve, then small businesses will need to start closing down or reducing staff numbers. ”
“A delayed reopening (to borders) could pose a substantial risk to many of these companies. JobKeeper is scheduled to end in March 2021 and given that cases are beginning to spike in Europe, and the fact that the US has never been in control of the outbreak, the answer could well be that our borders will not be open for tourism until late 2021 or 2022.”
“While there is still the potential that a vaccine could allow borders to reopen earlier, the RBA can’t rely on hope. The economy will need to do some heavy lifting over the next 3 – 6 months, and that means that small businesses in exposed sectors are going to need continued support. This is the uneven recovery.”
“The RBA must also keep a watchful eye on commercial property. While it seems to be faring okay, the same cannot be said for the outlook”
What about financial stability?
“Typically when thinking about financial stability, central banks will be concerned about making conditions too easy, which could lead to excessive risk taking, asset price bubbles, or rampant inflation. But the RBA has clearly stated that their usual concerns have shifted.”
“The RBA is focused on ensuring that rates remain low to help borrowers meet their debts. This means the RBA can be more aggressive than they usually would, as the argument for financial stability is flipped on its head—the risk isn’t that rates are too low; rather, that they are left too high.”
“For a central bank that has missed their inflation target for the past four and a half years, and has unemployment rate at close to 20-year highs, this creates a much longer runway to ease rates without being concerned about bubbles—especially coming from an RBA that has told us that employment is a key concern.”
“We believe the shift in the RBA’s thinking on this issue comes from the slow unwind of fiscal support for the household sector. As JobKeeper and JobSeeker are removed, the RBA will seek to ensure that they can mitigate the financial stability concerns of the borrowers potentially defaulting. Inflating asset price bubbles when the economy has had its largest contraction in decades is obviously the least of its concerns.”
The Prisoner’s Dilemma: Who cares what other central banks are doing?
“Put simply, if every other central bank is doing QE apart from us, then our interest rate curve will remain steep and the Australian dollar will start appreciating. Both of these will make economic conditions tighter and jeopardise our recovery.”
“The RBA needs to look at the effects of monetary policy offshore to determine how that can affect our relative position. In our opinion, this should not have changed over the past six months, as the impacts of easier policy offshore has been talked about for years. However, given the COVID-19 crisis globally is persisting longer than some had thought, perhaps this means the RBA is settling in for the long haul and taking more notice of what the policy differentials could mean.”
Once we capitalise zero rates into larger mortgages and the property market, even as Chinese decoupling continues, the cash rate is effectively destroyed. It will all be about the TFF and taking bank funding costs negative as the financial system slowly drowns in falling margins.
Unless we see APRA intervene, MMT and productivity reform.
