KangaNews DCM Summit RBA webinar
KangaNews hosted an exclusive briefing with the Reserve Bank of Australia (RBA) as part of the KangaNews Debt Capital Markets Summit 2020 online agenda. The reserve bank updated on the market-intervention measures it has rolled out since the start of the COVID-19 crisis while market participants discussed the RBA’s involvement from a range of perspectives.
KangaNews would like to thank the following headline sponsors of the DCM Summit 2020:
Laurence Davison Head of Content and Editor KANGANEWS
Chris Rich Staff Writer KANGANEWS
Christopher Kent, assistant governor, financial markets at the RBA in Sydney, addressed more than 300 market participants on the central bank’s operations in response to COVID-19, in a webinar that took place on 27 July.
Key themes in the webinar include yield-curve targeting and the shape of the sovereign-sector bond market, the term funding facility (TFF) and bank funding in general, and measures that could be enacted in future including the potential for a negative cash rate in Australia.
Kent and the panel of market participants agreed that the RBA’s decision to pursue yield curve control – a commitment to purchase Australian Commonwealth government bonds (ACGBs) at the three-year mark to ensure yields stay around 25 basis points – has achieved the intended stabilisation of the sovereign and semi-government market.
Kent said the RBA’s bond purchases “have had the desired effect” of redressing the imbalance of supply and demand in the Australian market. The volume of bonds presented for sale – and that were “priced to sell” at levels above mid-market price – in RBA auctions declined over time along with sovereign yield. The RBA had not been active as a bond buyer for some weeks by the time of the webinar.
Market stability returned despite a significant increase in sovereign and semi-government supply. Jim Malone, director, international fixed-income sales at TD Securities in Singapore, noted that close to A$165 billion (US$118.1 billion) of Australian government-sector supply came to market between 1 April and mid-July but yields had declined or held steady.
Demand has been robust beyond the RBA. Malone said the combination of Australia’s relatively steep curve compared with other G10 countries and cheap market access via repo and FX hedges combine to mean it “is now very cheap to finance Australian fixed income”.
The steepness of the Australian curve is also a topic of interest. When the RBA introduced its bond-buying programme, some commentators expressed surprise at the sole focus on the three-year point. The absence of longer-dated central-bank activity has reshaped the curve, and some panellists at the DCM Summit webinar suggested the RBA could have done more.
“The RBA has argued for and pursued yield-curve control. But the objective of QE is not to buy as few bonds as possible. It is to get the economy growing and to provide more stimulus,” argued David Plank, head of Australian economics at ANZ in Sydney.
The RBA has consistently stated its decision to target the three-year part of the curve because this maturity point is most relevant to local bank funding and borrowing in the real economy. Westpac Banking Corporation’s Sydney-based chief economist, Bill Evans, agreed that the RBA’s view on economic relevance is true but also identified another area he believes to be a focus for the reserve bank.
“It is interesting that the RBA is putting the currency front and centre in the policy of targeting the three-year rate,” Evans said – adding that the reserve bank “can’t seem to get the currency monkey off its back”.
Meanwhile, panellists largely anticipated the RBA would return to bond buying. Robert Thompson, vice president and macro rates strategist at RBC Capital Markets in Sydney, said it is inevitable that the market would test how far the RBA is willing to let yields drift. “The market is going to want to see the RBA step in at some level. The RBA said this is about market functioning and conditions, but this is not black and white enough for the bond market.”
This took barely a week to come to pass. On 4 August, as part of its monetary policy statement, the RBA announced it would re-enter secondary markets for the first time in nearly three months. While acknowledging government bond markets are functioning normally alongside a significant increase in issuance, the elevated level of three-year ACGB yield in the preceding weeks compelled it to intervene.
Kent also discussed the RBA’s provision of liquidity to the banking sector via the TFF. The facility had an initial allowance of A$90 billion, subsequently increased to around A$150 billion with additional allowances granted to banks that increase their lending to business since the facility began in April.
By the time of the webinar, TFF takeup remained far short of the total available. Kent noted that the drawdown was around A$26 billion, or 17 per cent of the total on offer. There are a number of reasons for this limited use of the facility, he added.
One is that many banks have accessed even cheaper funding from other sources in recent months, albeit at shorter tenors than three years. In particular, they have been able to issue bank bills at rates below 25 basis points. Similarly, deposits have ballooned and an increasing share of these funds has been paying rates of less than 25 basis points.
The RBA and panellists all believe, however, that the banks will ramp up their take-up of the TFF as the deadline of 30 September for the initial allowance approaches. Kent revealed the RBA is basing its expectation on direct liaison with the banks themselves.
“At that time, it will make sense for banks to compare the certain 25 basis point cost of the TFF with the uncertain cost of other sources of funding over the next three years, including bonds that would mature over that period,” he said.
Kate Pairman, director, capital markets at National Australia Bank in Sydney, had the same view. She said: “The TFF has replaced term debt maturities over the past few months and this will continue to be the case as we approach its deadline. We also expect banks will use the TFF to replace some of the short-term liquidity they are carrying with a consequent run-down in outstanding volume of NCDs, repo and term deposits.”
As deposit inflows have not subsided, it makes sense for the banks to wait as long as possible to draw TFF funds to extend the facility’s horizon. Pairman also pointed out a lot of flexibility is built into the TFF because banks can repay its funds at will.
One of the key aspects of the TFF and other funding dynamics on the Australian dollar credit market has been the absence of primary senior-unsecured supply from the major banks (see p38). With major-bank issuance typically resetting price levels after market dislocation, the first effect of the absence was to remove price benchmarks.
As the months have gone by, though, this vacuum has created the opportunity for offshore financial institutions (FIs) to execute Australian dollar deals at globally competitive price levels. The success of these deals can be attributed partly to the abundance of liquidity needing to find a home, Malone said.
The volume of such transactions has grown to an unprecedented level. Credit Suisse Sydney Branch’s A$1.75 billion deal on 19 May was the largest from an offshore FI in the domestic market for nearly a decade. It was surpassed in short order by Sumitomo Mitsui Banking Corporation Sydney Branch’s record A$2.4 billion print in early June and then by UBS Australia Branch’s A$2.75 billion deal on 23 July.
Further supply from offshore FIs will depend on cross-currency basis swaps and banks’ levels in core currency markets, Pairman said. But she expects there will be more issuance and for it to be well supported by investors given the liquidity backdrop. Large volume on offer could make the Australian dollar option more relevant to large global bank funders on an ongoing basis.
Malone added: “There are longer-duration buyers in Asia that tend to preference offshore names in Australian dollars to a greater extent than domestic investors. Big volume at longer tenors lends itself to more of these transactions getting done.”
“When we had the commodity-price boom following the financial crisis, the view was that it would become inflationary. What happened was the mining companies accumulated profits but they didn’t recycle them through the economy in a way that boosted demand and inflation. The same thing is going to happen again.”
Another focus of the webinar was the future path of RBA intervention and the possibility of negative interest rates in Australia. The RBA has repeatedly stated its view that negative rates do more harm than good, and Kent did so again in answer to audience questions.
“Our sense is negative rates would not be helpful in the current circumstances, and it is also not clear how helpful they have been elsewhere,” Kent said. “For instance, central banks that have pursued negative interest rates have not gone further into negative rate territory.”
The RBA clearly views going negative as more than just another cut. Kent said negative rates impinge on banks’ profitability and their willingness to lend, whereas merely low rates are not a constraint on capacity or desire to borrow. He also emphasised that the issue the RBA is confronting is on the demand side and that, in this context, negative rates “would not be helpful for macroeconomic conditions”.
For panellists, the issue is that the RBA’s hand could be forced even in the face of its own lack of enthusiasm for going negative. Thompson said: “If the whole world went negative the RBA would have to follow. It could be dragged kicking and screaming down that path.”
In the absence of a worldwide take-up of negative rates, Plank suggested the real question is what other measures the RBA will consider. “If the economy continues to be substandard and the RBA extends its forecasts out another year with inflation well below target and unemployment well above where it wants to be, I think it is unlikely it will be content to do nothing.”
Kent reminded the audience that further measures would not be without cost – but he was clear that it is impossible to rule them out. “We would have to think very carefully about the circumstances we would be in, for each and every one of them. It is broadly true under the current circumstances we face that further measures are not under consideration, but this could change if things get worse.”
The second lockdown in Melbourne could be the type of development that would force the RBA’s hand. At the same time, market participants are clearly still paying very close attention to the planned withdrawal of some government support measures and how the economy copes.
“The big question for me is how the economy responds to the slowdown in provision of liquidity,” Evans revealed. Westpac estimates direct stimulus from the federal government and the drawdown on superannuation contributed about A$65 billion to the economy in the June quarter with a further A$95 billion to come in the September quarter. Based on information about the extension of JobKeeper and JobSeeker, and all the remaining support measures, Evans estimated this will fall to A$15 billion in the final quarter.
The RBA may have to take its next steps in an economy where the expected growth and inflation drivers are weaker than it anticipates. Evans added: “When we had the commodity-price boom following the financial crisis, the view was that it would become inflationary. What happened was the mining companies accumulated profits but didn’t recycle them through the economy in a way that boosted demand and inflation. The same thing is going to happen again.”
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