UBS with the note:
Investors have challenged the RBA (again), as rate hikes are priced everywhere
Market pricing for RBA hikes moved materially in recent weeks, propelled by the shift in global front-end rates. There are currently ~70bps of hikes priced by the end of 2022, and ~120bps by the end of 2024 (with UBS forecasting rate hikes in 1H-23 to 0.5%). While this seems like a lot, pricing for rate hikes is ~similar to what’s baked in for the Fed; and still at the lower end of the G10 central banks’ spectrum. As we expected, markets have also (again) challenged the RBA commitment not to hike rates until 2024, with the ACGB 04/2024 now trading at ~16.8bps, well above the yield target of 10bps.
A fast-paced rebound + risks to inflation = a fast-paced normalisation
The rebound in the global economy has been faster than anytime in history; prompting investors to bet the monetary policy cycle will also be faster. While some central banks (eg RBNZ) decided to focus on the fact that a fast-paced recovery likely requires a fast-paced normalisation; others like the RBA have focussed on the recent history of inflation undershooting and aim to run the economy hot. However, importantly, the balance of risks to the global inflation outlook have shifted to the upside. With vaccine efficacy seemingly lasting ‘only’ 4-6 months, zero-Covid policies still ongoing in some places, and the possibility of new variants, there is a clear risk that disruptions may not be over soon. This doesn’t necessarily mean that inflation expectations will get de-anchored, but that supply disruption may push up CPI globally for longer, making it hard for central banks to call inflation transitory and not intervene. This is likely what has been driving the hawkish tilt in offshore central banks and market’s pricing.
Will the RBA join the rest of the pack? Yes, on QE; but not yet on rates
We judge markets are too complacent about RBA QE; and the RBA will start preparing investors to a quick end to QE. While our base case remains for the RBA to halve buybacks in February to $2bn/week and stop purchases in May, we see a risk that the Bank may opt for an earlier hard-stop of QE at the February meeting. By then, the RBA will be on track to own >35% of ACGB outstanding; an ownership share that elsewhere has usually meant increasing disruption to the functioning of the bond market. Provided the domestic economy rebounds in line with our expectations, we think that the RBA will be uncomfortable in owning such a large share of the market; especially, if global central banks have started the taper (or even stopped).
What about YCC?
UBS base case remains that YCC will be abandoned in 2022. However, while the inflation backdrop in Australia is arguably weaker than offshore, we judge that 1) the move away from COVID-zero policies; 2) rising vaccination rates; and, 3) the ongoing easing of restrictions suggest that the balance of risks for domestic growth and inflation is now tilted to the upside. Adding to that, the path towards normalisation recently started by global central banks reduces the pressure on the AUD. Together, this suggests that the RBA has a case to tweak its forward guidance earlier than we expect and allow for the possibility of hikes ahead of 2024, if conditions warrant it. The RBA’s soft defence of the YCC target this week – with a tweak to the repo facility, but no buybacks of the Apr-24 line (despite trading well above target) – suggest a discussion on the ‘pro & cons’ of YCC at the RBA will happen at November’s meeting.