PLANK The articles written in the past few weeks about the Fed forcing the RBA’s hand forget the experience last cycle. During the last tightening cycle the Fed went from 0.25 per cent into the 2 per cent area while the RBA cut rates. There is no mechanical link between the central banks. The linkages are indirect rather than direct: they tell us something about inflation and, potentially, about the currency.

MASTERS It affects the yield curve, though. A more aggressive Fed means the Australian 10-year bond yield goes a lot higher than it normally would have.

MCCOLOUGH This would be an indirect impact. Turning to where markets have alreadymoved, the RBA does not have as much work to do under such a scenario. Price action reflects commentary about the Fed forcing the RBA’s hand. It is certainly behaving this way at the moment, but I do not think it will have much impact on the RBA’s policy reaction function.

WHETTON The RBA has shown it wants to be patient, though it may not have this luxury for much longer – which is why we have June as the timing for the first rate hike. However, given the market has already priced in hikes, this will not change global investor outlook. The bigger story is negativeyielding debt going to US$2 trillion from US$14 trillion and markets thus becoming far more viable for domestic investors looking at yield.

The Australian market is now competing for capital more than it did previously. In this environment, we might have to go a little higher on yields to garner offshore interest. If, however, Australia continues pricing in much more than the rest of the world, such as two-year swap rates 65 basis points higher than the US, this would be factored in.

Therefore, if investors later judge the impact of rate hikes delivered – or price to be delivered – to be too much, they will want Australian interest-rate product, whether swap or bond, to go the big compression trade. It depends on how the cycle plays out, but where investors find their yield has changed globally.

PLANK This is a good point. It is important to realise the big difference to the prefinancial-crisis economy is that we are running a current account surplus. We do not need to finance a deficit, plus we are a capital exporter. If the rate differential persists or goes wider, the RBA will have to consider the currency implications.

One thing constraining how high the RBA goes is where global yields sit. If we run a current account surplus and go too far above global yields, the Australian dollar will rise and put downward pressure on inflation. Therefore, we will get more tightening through exchange rates than via interest rates.

MCCOLOUGH Long-end real yields in Australia are positive again, whereas global ones are not. Central banks have contributed to negative yield with their QE policies and we are beginning to hear some real yield arguments favouring the Australian dollar now. I agree there has been a shift in Australia’s relative attractiveness as a yield enhancement strategy, but the marginal investor is still behaving largely as it always has.

MASTERS Our market is trading very differently in a heightened volatility environment than it historically would have. The Australian-US 10-year spread would have been a lot wider but it is being held in. Perhaps we are viewed as a geopolitically safe place to allocate and investors are happy to keep their Australian holdings rather than selling, which they historically would have done in these conditions.

MCCOLOUGH The Australian dollar is considered a safe haven. While the big players are not adding, long-term holders who diversified into the Australian dollar after the financial crisis are bringing in new money at the margin.

MASTERS I do not think it will follow the RBNZ yet because we have the term funding facility (TFF), which is going to shrink the balance sheet. To date, the RBA has said it will hold to maturity. The maturity profile of the RBA’s bond holding does not hit in any meaningful way until 2025 onwards. Perhaps once the cash rate is seen to have hit its terminal rate, the RBA may decide actively to reduce its balance sheet. Currently I think it wants to raise the cash rate and the TFF will roll off first.

WHETTON The RNBZ has bonds maturing and it will be conscious of Treasury needing to pay for them. Treasury will borrow at a rate of NZ$5 billion (US$3.4 billion) per calendar year and reissue somewhere out the curve. The RNBZ is aware this influences the bond index and how the market absorbs extra supply. It is very different from the RBA holding to maturity. The TFF is one of the main differences between the approaches because the balance sheet naturally shrinks through the end of the TFF.

PLANK For the next shock or downturn it will be QE because the RBA will run out of cash rate cuts quickly. Even if we get to the 3 per cent area, per our forecast, it is not much in the context of a recession. There is a good chance the next easing and QE cycle comes before bonds mature, so the RBA will still own bonds.

Then we will be back in the previous situation, given some event happens every few years. QE, TFF or some nonconventional policy stays with us forever or for a very long time, because interest rates will not be high enough to be the sole instrument.

MASTERS Yes, if every other central bank starts to do QE again, the RBA will most likely follow if market conditions require it.