KangaNews DCM Summit economic outlook webinar
The latest in the KangaNews Debt Capital Markets Summit 2020 webinar series included an outlook on the Australian economy and bond market approaching the end of a tumultuous year. Discussion focused on the scale of fiscal support still required, how central-bank stimulus will be deployed and the outlook for key indicators including the housing market.
STATE OF PLAY
Roache We have almost run out of hyperbole to describe the events of 2020, but it is helpful to be a bit more prosaic in how we look the year. We had an enormous shock in the first half and we kept getting aftershocks as we carry on through the year.
What we have experienced can be characterised as a demand and supply shock, and it was global in nature. We have also seen shifting geopolitical relationships layered on top of these shocks.
We have seen an immense policy response that, in many ways, has been quite innovative. It has been absolutely fascinating to be an outsider looking at Australia because I think it has been at the cutting edge of global thinking about how to deal with these types of shocks.
It is going to be interesting to see how it plays out in the next 1-2 years. How are panellists thinking about the economic outlook moving into 2021, and how are fiscal and monetary policies shaping your views?
EVANS We expect growth will bounce back pretty well in the second half of this year. We are forecasting growth of 4 per cent – 1.8 per cent in Q3 and 2.2 per cent in Q4 – reflecting a recovery in Victoria in the last quarter.
Next year, we think it will slow to around 2.8 per cent. Before the budget we thought it would be about 2.5 per cent, but we expect households to spend around half their tax cuts so there should be a stronger consumer story.
The middle of the year will be the soft part in 2021. We are looking at 2 per cent annualised growth in this period, because it is when we will see how households and consumers deal with the withdrawal of JobKeeper and the winding back of loan deferrals.
Policy will continue to be stimulatory with the budget in May getting ready for an election in 2022. The Reserve Bank of Australia (RBA) is committed to keeping rates extraordinarily low.
Margins on banks’ mortgage books are at healthy levels, so the banks have further scope to cut their mortgage rates. I am very optimistic about the housing market from Q4 next year when we get over the headwind of deferred loans. We are looking at 3.5 per cent GDP growth in 2022.
I also have one comment on the budget. There were some big numbers in it but actual new policy only averages 1.2 per cent of GDP over the four year forecast period. Quite frankly, I was underwhelmed by the value of the new policies.
I think the government will do more with, for instance, JobSeeker. It will have to remain at A$850 (US$610) a fortnight and that will cost about A$4 billion a quarter. This means at least a further A$8 billion in the 2020/21 budget deficit and another A$16 billion in 2021/22.
I think the government will have to do more around the elimination of JobKeeper at the end of the March quarter. In particular, industries still affected by border closures will need help.
Roache It is not always obvious that a package is not as big as the headlines suggest. What do other panellists think about the budget’s impact on the growth outlook?
ONG We upgraded our 2021 growth numbers following the budget, though this was also driven by expectation of further measures from the RBA. More stimulus coming into the system, and sooner, has led us to take our GDP number for next year up to just less than 3 per cent from about 2.5 per cent – following a contraction in 2020 of about 3.5 per cent.
There is no doubt in our mind that the recovery is under way. But it is fragile. Confidence will determine whether the big-ticket budget measures underpin activity and hiring. As we look forward into an uncertain outlook, I agree that there will need to be ongoing fiscal and monetary stimulus.
It becomes somewhat circular, though. The numbers are firmer – if a bit patchy – but it becomes somewhat more challenging going into Q2 next year when some of the income-support measures are withdrawn and the loan-deferral period ends. The front loading of some of the stimulus, including what is likely to be more RBA stimulus, will help the recovery.
One of the lessons learnt from the post-financial-crisis period is the importance of not withdrawing support too soon. If anything, I suspect we will see more stimulus on the fiscal side – and Australia is very fortunate to have scope to do so. Our debt level is low by international standards and the RBA is in the early stages of unconventional policy.
COLHOUN It has been a very complex shock. Some sectors have done okay but obviously others have been smashed. Also, when thinking about fiscal and monetary policy it is important not to forget health policy. This is one of the biggest levers the government can pull to affect the economic outlook.
Hopefully, we get a vaccine soon. If not, we will have to work out how to live with this virus. Some overseas locations are now getting 30-minute COVID-19 tests at airports. Singapore is testing people when they arrive in the country. These are ways to get some activities back to normal if we invest in some of those testing systems. Governments also have to get the quarantine, testing and tracing programmes right. This is their biggest contribution.
The economy has been surprisingly good of late. Retail sales are above February levels and job ads, outside the big states, are the same. Consumer confidence is actually better than February and house prices are holding up much better than expected. We know this is because so much stimulus has been given out, though – and other sectors have more or less closed down.
Overall, though, the economy is so far performing a lot better than one would have thought given the numbers printed in Q2. I expect a further big bounce back in Q3, then we have to work through JobSeeker and JobKeeper.
I agree that removing support too early is always a worry. But the budget includes good support, including bringing forward income-tax cuts and giving incentives for business investment, while the RBA’s next move should help further. Recovery will be slow and grinding but it is turning out a lot better than we were expecting 3-6 months ago.
Roache Forecasts seem to downplay the risk of a fiscal cliff. Why has this risk apparently reduced?
PLANK We actually have a very different view on growth particularly in Q4 and we are quite concerned about the fiscal cliff. The budget didn’t boost our numbers relative to what we built into our forecasts because it delivered less than we were expecting and the form of the delivery was much more reliant on the private sector than direct spending.
I can understand the strategy the government has taken. The risk of delivering more tax cuts to households and tax incentives to businesses is that you can lead a business to a tax incentive but you cannot make it do the spending necessary to generate the tax incentive. I think the budget strategy is quite risky in this regard.
The pullback in fiscal spending in Q4 is enormous, so while we forecast a positive GDP number – helped a lot by the expected reopening in Victoria – it is not far above zero. The fiscal cliff will be tough to negotiate but there is a lot else going on, such as a bounce in consumer confidence after the budget that has been really encouraging.
I think the government will skate through it, but the fiscal cliff is a real challenge. With this in mind, there will inevitably be more fiscal spending to come. It is too late for Q4, but if we are right that the quarter ends up being a bit rocky the government will be very concerned about Q1 and Q2 when there is also the fiscal cliff.
ONG We agree that Q1 and Q2 will be challenging as some of the key income support, JobKeeper in particular, ends in March as do key loan deferrals for businesses and households. Part of the reason we feel a little more confident is that some of the measures expected from the RBA, as well as some of the budget measures, are being delivered earlier than we anticipated.
There is probably more stimulus coming into the system sooner than was our base case. I also agree, though, that if Q4 turns out to be more challenging we will see additional measures from the government either at the mid-year update or another time.
What we have seen in the past is industry-specific measures, such as an arts package. There is scope to deliver additional, targeted fiscal stimulus as needed – depending on how restrictions are eased and how Victoria opens up.
It is really a function of policy action, monetary and fiscal, and from a state and Commonwealth perspective. This is what makes us a little bit more confident as we head into next year, though there is no doubt Q1 and Q2 will be a more challenging period.
EVANS In my defence, one of the factors that hasn’t been discussed is the improvement of the balance sheet in the household and business sector. We are seeing that in the build up of deposits and of course we have seen a spectacular 20 per cent savings rate.
The question is if there is any lift in confidence that might see the household sector in particular use the strength of its balance sheet to lift spending. We saw the missing piece of the puzzle last week when consumer sentiment went up by 32 per cent in two months. This is giving me some confidence that the ongoing reopening of Victoria and other states should see more spending in the latter half of this year and into the first quarter of next. Then we see the soft patch associated with the elimination of JobKeeper.
COLHOUN I’d add, similarly, that reopening is the really big part here. Q2 was weak because a lot of things were closed – which is also why the savings rate surged. We were all at home and it wasn’t that easy to spend income or government support.
It is also worth noting that JobKeeper only rolls back if a business has recovered, so to a certain extent there is an offset. Not everyone who comes off JobKeeper will end up being unemployed. There are also the income-tax cuts, which have been brought forward. Again, it is not disastrous at the moment.
Housing – the upside surprise
Prognostications of doom have not come to pass in the Australian housing market – at least not so far. Economists are keeping a close eye on housing outperformance especially as some support measurers and loan deferrals roll off.
COLHOUN Based on the stress tests APRA [the Australian Prudential Regulation Authority] and all the other regulators get the banks to do every year, a scenario of really big falls in GDP and much higher unemployment should have produced a very different housing-market outcome than what we have seen. This tells us how important government and reserve-bank support has been.
I was really surprised to hear the RBA governor say rising house prices would be positive for financial stability. I thought that was unusual.
Roache The language the RBA is using is fascinating, including how clear it has been about what it is trying to do. How might its actions further affect markets?
NEWNAHA It is worth remembering that we wouldn’t be in this pickle without the pandemic. One of the things it injects into the market is uncertainty. This has a follow-on impact on underlying demand and whether businesses will remain solvent, which has further implications for the labour market and inflation. These are the factors driving global bond markets.
At the same time, sovereign-debt issuance is at a record level globally and there is an elevated level of corporate issuance as well. Despite the elevated levels of issuance, though, bonds are trading at multi-year lows and credit spreads are very narrow.
A number of factors are driving this. The first is a flight-to-safety trade from the uncertainty about how long COVID-19 will persist for. There is also a global hunt for yield, which is keeping yield low and spreads tight. At the same time, global central banks are willing to offer monetary accommodation and support via conventional and unconventional measures.
Overall, the message from the RBA governor last week was that it is watching economic and monetary-policy developments offshore because these will affect the Australian dollar and yield curve. Taking COVID-19 and offshore monetary-policy developments together, the RBA is going to have a clear impact on the market in 2021.
On the other hand, the data has been better than expected and the RBA has drawn attention to this. In fact, it think the data has started to turn to the extent that any accommodative measures the reserve bank provides are more likely to gain traction.
Roache When central banks run out of space with the interest rate they have to do other things. So far, the RBA has enacted yield-curve control (YCC) and compressed risk premia, and it sounds like the reserve bank believes, on balance, that this helping reduce financial-stability risks rather than increasing them. But what will the strategy if the RBA needs to do more?
PLANK The RBA effectively put ‘pure’ QE to the side. It is only now realising that central banks globally are buying a lot of bonds while the RBA, on a relative scale, is doing very little. We always expected it would shift to pure QE.
YCC was unsustainable in this rates world because it left the Australian yield curve too steep, which would attract capital inflows and push the currency above where it otherwise would be. Shifting to QE now would be a little earlier than we originally thought – but this is true for a lot of policies this year. Events have unfolded faster than expected.
The RBA’s policy decision about YCC at the beginning of the year was misplaced, they should have opted for full QE straight away. But we have got there anyway and it will be effective when they announce a reasonably large programme in a couple of weeks.
To not deliver now after signalling intent could lead to significant disappointment and possibly undermine the effectiveness of anything else the RBA does, such as a micro cash-rate cut to 10 basis points. I think we will get the micro cut and the delivery of QE.
To a large extent this is already priced in – we have seen our bonds compress sharply to the US. How much further this can go will depend on the direction of markets to at least some extent. If there is a sell off, the RBA leaning into a global curve steepening will prove quite effective. If US Treasuries start to rally, though, the RBA will have its work cut out for it trying to keep pace. Global movements will be quite an important determinant of how things go from here.
On the currency side, we think it is more about the RBA ensuring Australia is part of the pack rather than beating it when it comes to monetary easing. If we had stayed as we were – with the steepest yield curve in the G10 and relatively less monetary easing than everybody else – I think there was considerable upside for the currency. The RBA change has removed that potential.
EVANS The RBA’s view on the plumbing of the financial system is that negative rates would constrain the credit-creation process. We believe the 3 November RBA package will cut the rate offered to the banks on their deposits down to 1 basis point.
This will mean the money market rate will be 3-4 basis points. But it will also mean if banks offering a negative rate on deposits from corporates and institutional funds. In other words, we might start see evidence of negative rates right at the short end of the yield curve. I don’t believe at all that the RBA is preparing to set the policy rate negative but at least it will give the financial system an opportunity to see how it deals with negative rates.
Another view is that the cash rate can go to 5 basis points and thus the RBA can avoid negative rates. Given the difficulty of defending a bond target of 10 basis points, a 5 basis point exchange-settlement account might mean a money-market rate of about 7-8 basis points.
Regarding the general attitude toward negative rates, the RBA governor said it is extraordinarily unlikely and need to take that at face value. As a small open economy, it would be advantageous for the currency to have negative rates while everyone around you has positive rates. I think New Zealand is salivating about this prospect but Australia is well behind on that particular goal at the moment.
PLANK The problem at the moment is that the Bank of England (BoE) and Bank of Canada (BoC) are suddenly talking about negative rates. Come the middle of next year, Australia may be standing out as one of the few countries with positive rates. Going negative may not be our choice, in a way.
ONG We have been fairly vocal that a negative rate is a tool in the RBA’s kit though, like all central banks, it is absolutely not one it wants to reach for. But if there is one thing we have learned this year it is never to say never.
It was only late last year that the RBA governor talked about QE as unlikely – and look where we are less than 12 months later. I think David Plank is right, in other words. If other central banks head down the negative-rate path for overnight cash it would place pressure on the RBA to move in the same direction.
COLHOUN I agree with these themes. At the moment the RBA’s focus is on relative balance-sheet expansion. Since the pandemic, we calculate average central-bank expansion has been about 14 per cent of GDP, and the RBA has expanded its balance sheet by 7 per cent.
You could say it is 7 per cent behind. This might be one way to view how much more it has to do. But by whatever time we get to that 7 per cent, other banks will still be expanding their balance sheets – so we have more than 7 per cent to do over whatever timeframe the RBA chooses.
One of the key influences is what the Fed [US Federal Reserve] does – and it has remained against negative interest rates. If it changes, I think the market here would change very quickly too.
Roache To what extent is RBA policy having a permanent effect on the way the market works and how investors are thinking?
NEWNAHA The RBA’s role in the bond market will increase in 2021. Even after the TFF [term funding facility] increase the RBA still falls well behind its global peers in the scale of its balance sheet usage. The RBA’s assets on balance sheet is only 15 per cent of GDP – the lowest of its global peers. The RBNZ [Reserve Bank of New Zealand] is at 20 per cent, the BoE and Fed are at 35 per cent, the ECB [European Central Bank] is at 55 per cent and the Bank of Japan is in triple-digit territory.
We are trying to figure out how big the RBA’s programme could be under QE. As a back-of-the-envelope calculation, by June 2021 after all the TFF drawdowns have taken place the RBA will have a balance sheet of around A$420-450 billion. To get anywhere near the Fed or BoE, at 35 per cent of GDP, it suggests a QE programme of A$250-300 billion. This would be a significant amount of liquidity hitting the market.
We think most of the QE volume is going to be implemented in the 5-10 year part of the curve. Within this, we don’t think there will be much buying at five years, only because we have a five-year bond futures contract coming into the market that we don’t think the RBA wants to hijack. We will see bond purchases in the back end of that range – we think this is highly likely.
TFF-driven bond buying means there is less product out there for deposit-taking institutions to pick up and at the same time the supply of credit is going to drop – also because of the TFF. Pretty much most of the action will be in Australian Commonwealth government bonds (ACGBs) and semi-government bonds.
There is scope for supranational issuance to pick up and potentially for corporate issuance to hit the market as well – if banks decide not to lend the TFF money out to the market.
EVANS The RBA balance sheet is currently at A$300 billion, up from A$180 billion prior to COVID-19. If it went to the Fed’s level, it would be at A$650-700 billion – and the Fed has doubled its balance sheet since COVID-19.
I just don’t think the RBA would feel comfortable with that sort of aggressive expansion, coming from the starting point it has relative to where the Fed and BoE have been for a long time.
I would be really surprised if the RBA felt it was a target to expand its balance sheet to be the same size relative to GDP as the Fed and BoE. I think the RBA may be more interested in the size the RBNZ and BoC have got to, which is 20 per cent.
My view is that we are going to get A$150 billion from the TFF between now and June and there may be some scale back of reverse repos – so I think A$100-150 billion would be the maximum the RBA would be comfortable with.
ONG A ‘proper’ QE programme could be anywhere from A$100 billion to A$180 billion. I suspect it is probably going to be toward the lower end of that range, around A$100-125 billion. I note, though, that central bank programmes globally tend to start heading in one direction and that is to be upsized.
One discussion point is whether QE will include semi-government paper. We think there is merit in doing so but even if the RBA doesn’t include semi-governments this time around, that sector can be a key beneficiary. It could also be included in the programme further down the track as it wouldn’t be surprising to see that QE programme upscaled at some point if needed. This seems to be the pattern around the globe.
NEWNAHA I should say that I agree about the RBA’s willingness to grow its balance sheet. I was just pointing to how large a QE programme could be. We think the RBA will want to maintain maximum flexibility but the size of these QE programmes typically only goes higher. We have seen that from the ECB, too – it keeps saying it has more tools available.
I think over time A$200-300 billion is a signpost more than anything else. But yes, a programme of around A$100 billion in the first year seems entirely likely.
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