Unlimited ACGB purchases and direct bank funding to support RBA’s bridge

The reserve bank has placed no limit on the scale of bond purchases beyond saying they will continue for as long as necessary to keep the three-year sovereign bond yield at about 0.25 per cent until economic recovery begins. The TFF offers three-year lending to banks at a fixed rate of 0.25 per cent, with “at least A$90 billion” initially available.

The facility’s goals are to “reinforce the benefits to the economy of a lower cash rate, by reducing the funding costs of ADIs [authorised deposit-taking institutions] and in turn helping to reduce interest rates for borrowers” and to “encourage ADIs to support businesses during a difficult period”.

The second goal will be achieved, the RBA hopes, by increasing the volume of funding available to ADIs if they increase lending to business – especially SMEs. “Eligibility and continued access to the TFF will…be dependent upon ADIs acting, in the opinion of the reserve bank, in good faith and in a manner consistent with the objectives of the TFF,” a notice accompanying the announcement states.

The RBA has also announced that exchange-settlement balances at the reserve bank will be remunerated at 10 basis points rather than zero, as would have been the case under the previous arrangements. “This will mitigate the cost to the banking system associated with the large increase in banks’ settlement balances at the reserve bank that will occur following these policy actions,” the announcement reads.

At the same time as the RBA announcements, the Australian federal government stated it planned support for nonbank and smaller ADI lenders in the securitisation market in the form of an investment capacity of A$15 billion, to be provided to the Australian Office of Financial Management (AOFM). This is almost as much as the AOFM’s securitisation investment programme rolled out during the financial crisis, not all of which was allocated.

The Australian Prudential Regulation Authority also got involved, announcing soon after the news of the other measures a temporary relaxation of requirements for common equity tier-one (CET1) capital. The goal is to allow the banks to facilitate lending to the wider economy, including small businesses and households, which are expected to come under stress in coming weeks and months.

In a speech following the RBA’s announcement, Lowe explained: “This is a comprehensive package to lower funding costs in Australia and support the supply of credit…The term-funding scheme and the three-year yield target are both significant policy developments that would not have been under consideration in normal times.”

Lowe’s tone made clear the gravity of the task the reserve bank is undertaking. He emphasised that the TFF and government bond purchasing both carry financial and other risks for the reserve bank and both represent significant interventions by the bank in Australia’s financial markets.

He was also at pains to stress that the reserve bank board did not take these decisions lightly. “In the context of extraordinary times and consistent with our broad mandate to promote the economic welfare of the people of Australia, we are seeking to play our full role in building that bridge to the time when the recovery takes place,” Lowe explained.

Market participants had been certain that QE was coming in the lead-up to the RBA board’s extraordinary meeting and the announcement of the purchasing programme. Most analysts predicted this would come in the form of yield curve control (YCC), which would anchor government bond yields and, hence, reduce risk-free rates across the curve.

Lowe said the 0.25 per cent target yield on three-year Australian Commonwealth government bonds was consistent with the board’s expectation that the cash rate would remain at the same level for some time but not forever. In a Q&A, he suggested he would be surprised if the cash rate were still at this level in 10 years – but not if it remained there for three.

On the subject of purchase volume, Lowe added: “Rather than quantities or the size of our balance sheet, our focus is very much on the price of money and credit. Our objective here is to provide support for low funding costs across the entire economy…We are prepared to transact in whatever quantities are necessary to achieve this objective.”

The RBA began multiprice auctions for bonds on 20 March, making announcements at 11.15am on each day of purchase. It states: “The size and composition of purchases [are] determined subject to market conditions and vary across auctions.”

The immediate market reaction to the deployment of QE in Australia was a rally in three-year bond yields but a steepening of the curve. Damien McColough, head of rates strategy at Westpac Institutional Bank (Westpac) in Sydney, reports that three-year yields fell by 15 basis points but remained 15 basis points above the 0.25 per cent target.

The 10-year government bond sold off heavily after the announcement before recovering to sit 50 basis points wide on the day, says Gareth Aird, senior economist at Commonwealth Bank of Australia (CommBank) in Sydney, in a research note. He adds that this was indicative of market disappointment that YCC did not target the 10-year bond.

Lowe says YCC is being directed at the three-year rate because it “influences funding rates across much of the Australian economy” and is consistent with the term of the bank TFF. The RBA will be buying government and semi-government bonds across the curve, though.

Lowe would not comment on the specific conditions required for lifting the target yield on the three-year bond but said the economy would need to be in recovery and heading towards an unemployment rate of 4.5 per cent – the nonaccelerating inflation rate of unemployment.

The TFF, meanwhile, attempts to mitigate a lengthy credit-market closure. It encourages banks to lend by initially capping funding for individual banks at 3 per cent of outstanding credit and making access to further funding conditional on banks increasing their lending to businesses, particularly SMEs.

For every extra dollar a bank lends to a large business, it will be eligible for an extra dollar from the TFF. For every extra dollar of lending to SMEs, banks will be eligible for an extra five dollars. Lowe says additional lending to the already heavily indebted household sector will not make banks eligible for additional funding through the TFF.

Banks accessing the initial funding based on current outstanding credit have until the end of September to draw funds, while those seeking additional funds based on increased business lending have until the end of March 2021 to draw on the TFF. Lowe says institutions accessing the scheme will need to provide the usual collateral to the reserve bank, with haircuts applying.

The scale of the TFF could lead to Australian banks making minimal draw on capital markets. Brendon Cooper, director, credit strategy at Westpac, notes the facility will probably cause a “sharp fall in the requirement for traditional credit market supply in the short term”.

The RBA had already begun implementing support to short-term money markets via an increase in repo operations. It reiterated in its 19 March announcement the commitment to conducting one-and three-month repo operations daily and six-month operations weekly for as long as necessary.

Analysts applauded the earlier measures for helping to provide immediate relief to front-end funding conditions. Martin Whetton, CommBank’s Sydney-based head of bond and interest rate strategy, said in a 17 March research note: “The injection of repo funds has hit a record level, and the RBA’s one-, three-and six-month tenors, accompanied by solid volume, have narrowed the spread of repo to overnight indexed swap.”

Making sure repo operations are functional and cost effective for increased usage by banks is also the motivating force behind the RBA’s decision to lower the rate at which exchange-settlement balances are remunerated.

Exchange-settlement balances rose sharply as the RBA began its increased repo operations and these increases are likely to continue. Lowe said balances had risen to A$20 billion by the time of the announcement from A$2.5 billion a month previously.

The combination of the increased need for the system and a desire to make banks as willing as possible to use the facilities being made available made the RBA decided to reduce the rate, Lowe explained. He added that the RBA would continue to monitor the cash market and was prepared to make further adjustments if necessary.

Lowe was keen to stress the sound fundamentals with which the Australian economy and financial system entered the latest crisis. “Before the coronavirus hit, we were expecting to make progress towards full employment and the inflation target, although that progress was expected to be only very gradual,” he commented.

The reserve bank is confident this state of stability and prosperity will return once the spread of COVID-19 is brought under control. However, Lowe also acknowledged the undeniable pain that people and the economy will experience in the near term.

“We are expecting a major hit to economic activity and incomes in Australia that will last for a number of months,” he said. “We are also expecting significant job losses. The scale of these losses will depend on the ability of businesses to keep workers on during this difficult period.”

With this in mind, Lowe said the RBA, the government, regulators and financial-market participants all have a role to play in building a bridge back to prosperity and stability. “The timing and strength of that recovery will depend in part upon how successful we are, as a nation, in building that bridge to the other side,” he commented.

The RBA wasted no time getting stuck into activity in the market following the announcement of unconventional policy measures on 19 March. Early signs for the asset purchasing were positive, analysts say, as three-year government bond yield headed towards its target in the early days of implementation.

The reserve bank made A$5 billion of government bond purchases on 20 March and A$4 billion of purchases each on 23 and 24 March. It also began buying further out along the curve and in the semi-government sector in short order, including acquiring A$2 billion debt issued by various semi-government issuers on 25 March.

The central bank opted for a target on the three-year government curve to provide an anchor point for yield across the curve without being obliged to buy a particular quantity of bonds. It also determined that the three-year point was most relevant to credit in the real economy.

Extreme volatility in bond markets spurred the decision. Government bonds across the curve first rallied as investors sought safe havens, then blew out as it became clear the government would need to inject substantial fiscal stimulus to keep the economy afloat.

The rally in yields in response to RBA purchasing probably brought some relief to market participants. In a daily research note published on 23 March, CommBank’s Melbourne-based senior fixed-income strategist, Philip Brown, said the RBA’s purchases on the same day were executed in a much tighter range than those on 20 March. All lines on offer had a lowest accepted yield about
1.25 basis points lower than the weighted average, compared with up to 8 basis points in the previous auction.

Brown added that this range narrowed again in the 24 March auction, with all three lines bought having a lowest accepted yield within 1 basis point of the average accepted yield. The RBA does not publish the highest accepted yield.

Brown tells KangaNews the policy of YCC gives the RBA a degree of nuance and an ability to make judgement calls. The same, he argues, cannot be said of volume-based purchasing that other central banks deployed in earlier QE packages.

David Plank, Sydney-based head of Australian economics at ANZ, points out: “The way the programme has been designed means the RBA is virtually guaranteed of success. There is no specified timeframe for achieving the target, no quantity of bonds specified for purchase and no specified metric for the curve flattening.” Plank adds, however, that the curve became steeper in the long end coming into the RBA announcement and the central bank would probably like this to flatten.

The issue, as Westpac Banking Corporation’s Sydney-based chief economist, Bill Evans, discussed during the KangaNews economists roundtable on 23 March, is that the 10-year soverign bond is more susceptible to global moves than shorter-dated bonds and, therefore, more out of the RBA’s control.