A bridge to where?

On 23 March, KangaNews hosted a live dial-in featuring some of the leading market economists covering Australia. It was the same illustrious panel that was to be a highlight of the KangaNews Debt Capital Markets Summit – which had been scheduled for the same day. In a rapidly changing world, the economists provided insight into a unique and vast, but practically unquantifiable, risk.

KangaNews would like to thank ANZ, RBC Capital Markets, TD Securities and Westpac Institutional Bank for supporting the live session and the following coverage, and Deal Roadshow by Finsight for providing the dial-in facility.

  • Bill Evans Chief Economist, Managing Director and Global Head of Economics and Research WESTPAC BANKING CORPORATION
  • Prashant Newnaha Senior Asia-Pacific Rates Strategist TD SECURITIES
  • Su-Lin Ong Chief Economist and Head of Australian Research RBC CAPITAL MARKETS
  • Richard Yetsenga Chief Economist ANZ
  • Laurence Davison Head of Content and Editor KANGANEWS

Davison The emerging COVID-19 situation seems eerily similar to 2008-09 in that events keep overtaking the response – and at a seemingly accelerating pace. Has what was originally a public health crisis with economic consequences officially turned into a market contagion with major ongoing concerns for liquidity and credit?

EVANS It is fundamentally a health crisis. But the economy and markets are being affected by the actions that need to be taken to deal with the health crisis. In Australia, the government is surprising us every day with further shutdowns that will affect the economy.

We don’t know when the crisis will peak. Wuhan’s lockdown started on 23 January and it appears to have come out the other side. That is two months but it is under best practice. We certainly do not think Europe, the US and Australia are exercising best practice.

While the crisis is playing out, government policies will constrain growth and that feeds straight into markets.

What worries me the most about markets is that the US seems to be the country the least on top of this. Even if Australia gets on top of its own issues, we will still have massive volatility in the markets until confidence returns to the US.

ONG The impact of the virus on the broader economy is creating uncertainty that is feeding into the volatility in markets. Uncertainty is causing the greatest concern.

I mean the uncertainty about the depth of the problem, its duration and the response from central banks, government and regulators. Measures are constantly being announced, and even when there are delays in those measures, it adds to volatility.

The impact on the broader economy is feeding through to the credit space. This is where we are seeing the greatest stress in Australia and globally. Credit spreads have widened and we are trying to figure out how significant the impact will be on the real economy.

The volatility in markets, particularly in credit, comes back to positioning as well. In the last few years, we have been in a world of low yield with a lot of corporate issuance. The investor side has been overweight in its credit exposure and this has exacerbated, to some degree, the movements we have seen over the last few weeks.

This is going to be in focus for the next little while as we see ongoing implementation of new measures. What we are getting from the central banks is particularly encouraging but we are a long way from real stability. It comes back to the core questions with this virus around depth, duration and spread. I think we are still a long way from understanding it.

YETSENGA I am less worried about the uncertainty. Our problem is perspective. In a sense, this is kind of our Hurricane Katrina moment: there was a storm approaching that was pretty easy to see and the levies were never designed to deal with a storm of that severity. Yet everyone just stood and watched.

When we look back at this period, we will note that we could model the spread of contagious viruses quite easily. Wuhan taught us that we will face an avalanche of health issues if we don’t exercise draconian social measures. If our health system is not prepared, the result will be major societal disruption and existential questions none of us thought we would have to consider.

Beyond that, we don’t have enough redundancy in the way we run our economies these days. We are certainly more fortunate in Australia to have low debt levels in the government sector but the household sector is very indebted.

The US corporate sector is very indebted, and governments, households and corporates in parts of Europe are incredibly indebted.

If this is a health problem first, what we are doing now is like starting to apply chemotherapy. The problem with chemotherapy is that it weakens the body as it is trying to heal it. In this case, that means worsening the economics.

The data we already have makes tough reading. Restaurant bookings in North America are down 90 per cent year-on-year, China retail sales are down 20 per cent and state-by-state jobless claims out of the US suggest we have seen the fastest increase in claims ever.

It takes only 100,000 layoffs in Australia to add 0.8 per cent to the unemployment rate. I can probably count that just in the last couple of weeks without having to think too hard about it.

We are still in the bad-news phase of this crisis and, until we deal with the health issues, the economic policy response is just trying to catch up.

NEWNAHA Singapore is pretty much on the doorstep of China and at one time the greatest number of infections outside of China was in Singapore, if we exclude the cruise ships.

The way the Singapore government has responded has been exceptional. It has been quick and that has helped keep conditions under control. However, it is easier to monitor the developments of this virus in smaller countries.

For example, the Ministry of Health’s website is so detailed you can find out whether there is a person on your street who has COVID-19. You don’t know any of their personal information but you will have an idea of where they have been and where they most likely got it. Having this amount of information is incredible and has kept people well informed and calm.

We have been running on a disaster-recovery platform for the last six weeks and it feels like other parts of the world are starting to move towards that.

Even so, with the news deteriorating more and more overseas, there is a greater risk that we will get a further clampdown in Singapore. Not all stores are shut yet and most are operating as usual, which was a bit of a surprise for me. But I expect the draconian measures we have seen in Australia to start filtering into Singapore.

“We have been in a world of low yield with a lot of corporate issuance. The investor side has been overweight in its credit exposure and this has exacerbated, to some degree, the movements we have seen over the last few weeks.”


Davison QE and fiscal packages have a common problem at this stage – it is hard to stimulate an economy if people are being told to stay at home. Is this stage of the response just about having factors in place to prompt a quick economic recovery when one is possible? Is it possible to have any idea of the scale of the ‘bridge’ that will be needed to support an inactive economy through to the other side?

YETSENGA I don’t think we know the scale of the package required. We can model the spread of the virus but very small changes to any assumptions can make enormous differences.

For example, if you model the spread using a three-stage process, with three different assumptions for R0 [‘R nought’], or the replication rate [the number of people each person infected goes on to infect], shifting between an R0 of 0.8 or 0.9 for the third stage in the US nearly halves or doubles the number of people ultimately infected.

The more miscommunication there is around the early stages of the medical and logistical response, the more it widens the span of likely outcomes. In the US, political divisions are still hurting their response.

Economic policy can respond only to the information it has at the time. What is clear is that budget deficits will become very, very large, very, very quickly.

ONG I agree, and I’d add that whatever we think is the right amount of stimulus to build this bridge, the amount ultimately needed is probably more. This is why we are seeing additional policy announcements globally every other day.

We can take comfort from the fact that Australia has more scope on the fiscal side to deliver stimulus. We are in the fortunate position of having debt levels that allow measures to be scaled up and down.

The same goes for the authorities. The package the Reserve Bank of Australia (RBA) announced in mid March can be adjusted upwards. Its term-funding facility, what gets targeted, the quantum of buying for government and semi-government bonds and the potential to extend into other securities can all be increased.

There is scope to do more, and I suspect we will see more from the government and the reserve bank if necessary.

EVANS Two weeks ago, we forecast a recession and we thought that was bold. Then we saw the first fiscal stimulus package and we maintained our forecast because a lot of the so-called stimulus will be saved. People will not be going out and spending money, so there will be limited stimulus to spending.

I I am not sure the key tenets of the current support package are going to have much of an impact in the face of all the policies that need to be implemented to deal with the health crisis.

NEWNAHA The government, regulators, the RBA and health officials are all working around the clock to contain what is an extraordinary, multidimensional problem. Monetary policy measures have been bold and they have been quick. But it feels like monetary policy has done what it can, for now. The focus is shifting to fiscal and containment policies.

We feel confident the scale of the bridge will need to be larger. The first fiscal stimulus was never large enough, at 1 per cent of GDP. The second round was delivered over the weekend but even taking all the stimulus together, 70 per cent is targeted at businesses. It does not feel like enough is targeted at demand. As Bill Evans said, why would a business borrow when its revenue has been wiped out?

The 100 per cent wage subsidy maxes out at A$100,000. How are companies supposed to keep everyone employed if their average wage is at this level?

The risk is that we are going into a lockdown and we will need further stimulus. As Su-Lin Ong says, there is scope to broaden monetary policy, by extending purchases to corporate bonds, for instance. But if the situation deteriorates further, as it did in the US during the financial crisis, there will be talk of the need for a bail-out fund as well.

This should be kept at the back of the mind. What we have seen in the past is that bail-out funds tend to be 3-5 per cent of GDP. It feels like the bridge will need to be lengthened and widened. We expect more developments over the coming days and weeks.

“We feel confident that the scale of the bridge will need to be larger. Taking all the stimulus together, 70 per cent is targeted at businesses. It does not feel like enough is targeted at demand.”

YETSENGA We should expect the public sector in Australia and other countries to take on private-sector credit risk, whether this comes through the central bank or the Treasury. Policymakers will be thinking about where this risk should go, but it will likely move into the public sector at some point.

The response has not been all that well coordinated in some ways. In Australia, the second-largest element of the first fiscal package was more than A$4 billion to pensioners, who are precisely the people we do not necessarily want to be going out spending money, given the health issues. They also have a low marginal propensity to consume.

Think about what response is appropriate as this crisis unfolds. SARS is the nearest thing to compare, and it was short and sharp. Its outcomes suggests the response to COVID-19 should be to protect business. The problem is the COVID-19 crisis is much longer and deeper, and we need to protect people. If there is no demand on the other side, we won’t prevent the adjustment.

EVANS To Richard Yetsenga’s point, the package is a bit more than A$60 billion, of which A$32 billion is payments to businesses that they get only if they keep their employees. The subsidy is the tax the employees are paying.

People at this sort of wage level are paying only A$20 out of A$100 in tax. If a business is offered A$20 to keep someone they are paying A$100 but the business isn’t selling anything, it still will have to let that person go. This means much of the A$32 billion will never get paid – so it would not be part of a stimulus.


Davison What do economists make of the precise nature of the RBA’s QE package? Su-Lin wrote on 16 March that she expected to see measures “tailored to the current circumstances”. How well did the RBA track to expectations?

ONG Thereserve bank did its first lot of bond purchases on 20 March, the day after it announced details around its unconventional monetary policy. We thought it was a strong start. It announced in the morning that it would buy A$5 billion across four lines – the 2022, 2023, 2027 and 2028 government bonds.


what we can see, the RBA was aggressive in price and bought the full amount. It was a strong signal following a tough week when markets had to wait for the details of the RBA’s policy. There was a lot of uncertainty, dislocation and volatility.

We are not sure how much the RBA will do going forward, or how often, but it has established some credibility with this strong start. It is clearly committed to the 0.25 per cent target at three years and is prepared to step in further out on the curve when markets are volatile and dysfunctional. It is also prepared to show up in size and pay up if needed. It was a good start but we will be watching closely over this week. It is early days.

The RBA has also signalled it is prepared to step into the semi-government market, which has had a tough couple of weeks. We know that as the burden increasingly falls on fiscal policy, the states are delivering more and that further announcements are expected. Maintaining strong functioning of this market is important, too.

EVANS All credit to the RBA. It was a brave effort, when the three-year ACGB [Australian Commonwealth government bond] was trading around 0.6 per cent before the announcement, to come in and announce a 0.25 per cent yield target. It has achieved this, so all credit for being brave and locking in the 0.25 per cent target for three years.

But we need to ask why the bond market is misfunctioning. It is due to the accumulation of over-regulation as a knee-jerk response to the global financial crisis.

The RBA should not try to target the 10-year ACGB or it might be embarrassed because that will be driven by the malfunctioning of the 10-year US Treasury curve. It should keep targeting the three-year yield and buy across the maturity curve but stay away from targeting the long end of the curve.

“We need to ask why the bond market is misfunctioning. It is due to the accumulation of over-regulation as a knee-jerk response to the global financial crisis. Bond markets are misfunctioning because of over-regulation.”

Davison Is yield curve control the best way of going about this?

EVANS I think what the RBA has done is fantastic. Other central banks have just set quantities [for bond buying] but they do not know where the market will go. The RBA is setting a price so at least it is testing itself and will be answerable to the market. If it gets the price down, that will help the economy much more than just purchasing bonds.

The other interesting thing, though, is the timeframe. We all remember the taper tantrum in the US, and we have to ask whether we will have the same when the RBA stops these purchases. The market wants to do something all the time and it will assume the central bank is planning to hike. The curve will be volatile when the RBA stops, but I don’t expect this to happen for a couple of years.

NEWNAHA I think the RBA should be applauded for what it has achieved with its move into QE. It has given itself maximum flexibility to achieve its objective.

The RBA has had the benefit of studying the QE its peers at the European Central Bank, US Federal Reserve, Bank of Japan and others have undertaken. It has not bound itself to any size programme, which I think gives very little room to disappoint markets. This also extricated the RBA from having to justify its moves. It has enormous flexibility, which is a great outcome.

I think, as Su-Lin Ong says, the message from the central bank is that it is committed and nothing is off the table. We saw this even before the announcement with the RBA injecting liquidity into the repo market. Historically, the RBA does not take an active involvement in the repo market – it has been content for repo to do its own thing. But it stepped in and picked up involvement in a proactive way.

This should give market participants comfort that a blowout in repo-OIS [overnight index swap] spread is unlikely to repeat to the same degree if there is another round of funding stress. Hats off to the RBA.

ONG We said for a long time that for unconventional policy to be successful in Australia it had to be tailored for Australian circumstances. These include the nature of our mortgage market and our lending environment.

think this is very much what we have seen from the RBA in the early stages. There is a reason three-year yield is the target and the term-funding facility is also tailored to that tenor – around where most borrowing occurs. These are encouraging signs for success.

We were never going to adopt the unconventional measures that have taken place in other parts of the world. What we have seen so far is encouraging. We may see more targeted measures if necessary.

Australian QE and capital markets

The Reserve Bank of Australia (RBA) is rolling out QE to support local liquidity and keep lending rates low. The likely consequence for capital markets is a private-sector hiatus.

DAVISON What are the likely consequences, for debt-market activity, of the RBA’s package announced on 19 March? It seems likely that the RBA is going to suck up quite a lot of government-sector and bank bond supply while the Australian Office of Financial Management (AOFM) is likely to be the main bid in the securitisation market. Will there inevitably be a private-sector market hiatus while these measures are in effect?

NEWNAHA I think this is a fair assessment, at least in the near term. I agree that it feels as if the news is going to get worse before it gets better. The risk is we are going to get a continued blowout in credit spreads, which would keep investors skittish. If this is the case, it will obviously affect the amount of issuance we have coming into the market and the appetite to absorb that supply. At the moment, the focus is going to be on liquid, highly rated issues for the next couple of months.


Audience question If you accept that the spread of the virus will determine the economic impact, can you talk about your base cases for the number of people affected in Australia at peak and when this is likely to occur?

EVANS Our base case over the last couple of weeks has been that the peak will be at the end of June, which is about five months since people became aware of the virus. The only thing we have to go by is South Korea and China’s success. It took two months from lockdown for the virus to be contained in Wuhan.

Clearly what we do not know is whether exponential increases in challenges occur if a country is lax in the early stages.

Richard Yetsenga has done interesting modelling on this. I worry that our end-of-June timing is too optimistic. The prime minister has talked about six months but we are unsure what he means. Is he saying that in six months there will still be some policies in place but the recovery in markets and confidence will have already happened? Markets are probably 6-12 months ahead of the economy. The end of June is still our central view but this is under review.

YETSENGA This is certainly the right question but none of us is trained in the things that would make us experts in answering it.

All the health experts tell us there won’t be a vaccine for 12-18 months so the downside scenario is that this is not a 3-6 month problem but a 12-18 month problem. I suspect most people are focused on how deep the initial fall in activity is, and as days go by it is obviously getting deeper. How long will activity need to stay repressed and how long will movement restrictions need to stay in place?

NEWNAHA The best guide we have for the speed of the spread is South Korea and Italy. These present daunting prospects for what is potentially ahead in the US, UK and Australia. Developments in the next two weeks will be critical.

I hope we can carve out a coronavirus trajectory similar to that of China. Then there would be some basis for saying we have this under wraps. But we need to remember that the measures China took were draconian. People were essentially locked up and could not get out. If they could get out, it was one person at a time per week.

It would be a big test for Western countries to adopt a similar approach. For now, we just need to be on top of containment. HIV and malarial drugs are supposedly helping to ameliorate some issues but the window is closing rapidly.

As Bill Evans said and Richard Yetsenga’s work suggests, it feels like things are likely to get worse before they get better and we will all need to revise our forecasts.

ONG The added risk for Australia is that a 3-4 month timeframe for a peak goes into southern hemisphere winter. A revival in virus spread then would still be possible, even if the northern hemisphere has it under control by then.

I echo Richard Yetsenga’s comments around our focus being on the fall in activity during the first half of this year. But one of our concerns is that if we eventually do come out of this – whenever that is – we need to remember Australia went into 2020 with soft growth numbers. Private demand was weak and the economy was fairly lacklustre.

Many of the challenges Australia has – low productivity, structurally low wage growth and high indebtedness, for instance – will still be present when we come out of this. The weakness of the labour market will exacerbate them. There are many challenges beyond the initial contraction in activity.

EVANS Richard Yetsenga quite rightly points out 100,000 jobs is about 1 per cent on the rate. We have about 1.3 million workers in retail and nearly 1 million in accommodation, travel and recreation. That is scary.

YETSENGA Another issue that will not go away is the question around the inflation target. So far, no country has sustainably extricated itself from QE once it has started into it.

Australia has now gone down this track, and we all agree this is appropriate, given the circumstances. But as this crisis passes, we will again be looking at the monetary policy framework and wondering whether it is fit for purpose.

Not only will we be undershooting the inflation target but the world is likely to emerge with significant excess capacity, so it is hard to see how generalised inflation picks up at all.

There is also much closer cooperation between fiscal and monetary policy, again as an appropriate crisis response, but it further raises questions around the independence of central banks and whether we have drifted away from inflation targeting in everything but name.

“As this crisis passes, we will again be looking at the monetary policy framework and wondering whether it is fit for purpose. Not only will we be undershooting the inflation target but the world is likely to emerge with significant excess capacity, so it is hard to see how generalised inflation picks up at all.”

Audience question Everyone on the panel seems to have great confidence that COVID-19 will be contained. But outside China, and possibly South Korea, the numbers are getting very large, very quickly. In Australia, based on patterns elsewhere, there could by 3 million cases by the end of April. What does the panel think are the chances of some developed countries not getting on top of the crisis?

EVANS We have seen best practice executed in China and South Korea and it is only a matter of time before Western countries follow suit.

NEWNAHA Globally, health systems are not ready to cope with the onslaught of this virus. I hope for a good outcome, for a drug to be developed in the next six months. But all the measures we have on the fiscal side are just a bit too late. We need payments to come through, ASAP.

agree we need a containment strategy. The risk is that this gets out of control. This is why, fundamentally, I am a bit more negative in the near term.

We need to watch what is going to happen in the next two weeks. The quicker we act, the better. We do have some hope if we look to what China and South Korea have been able to achieve.

Davison Until recently, most economists seemed to be talking about positive growth resuming in H2 of this year. Is it already unlikely that a V-shaped recovery will happen, given the escalating scale of the problem?

EVANS Our view has been that growth would be positive in H2 but this has been predicated on the peak being at the end of June with confidence returning in the second half as restrictions ease. Discussions here indicate there is an expectation that social restrictions could last well into the September quarter. If this is the case, it will be difficult to see positive growth in H2.

YETSENGA The use of letters is unfortunate because they imply some symmetry. Whether it is U-shaped or V-shaped, there is a sense in using this terminology that the world will go back roughly to where it was before the crisis started. I think working on this presumption would be a big mistake.

We have alluded to a few things on today’s call that indicate the world will be different in immeasurable ways. We are moving closer to modern monetary theory as a way to implement policy. I have many problems with this but it is the reality. There will be a health legacy, much like there was in Asia after SARS, in which a lot of social habits will permanently change.

The idea of businesses running very long and complex supply chains across the world has been challenged by the trade wars and now by this. The great hope for Chinese economic growth in the next decade has been Chinese consumers reducing their savings rate. This seems a big ask after these events.

I don’t think there will be a ‘U’ or a ‘V’. I think we will get through the collapse and the recovery will be slow, and it will be towards a different environment.

EVANS This is a good point. The last time we had a huge, global shock, the world changed. There was a massive increase in regulation and great criticism of banks. There will be a structural change this time and Richard Yetsenga identifies many issues that will come up. I think the unemployment rate will be permanently higher, on average.

NEWNAHA Prime Minister Scott Morrison has said this is a one-in-100-year event and unlike anything we have seen before. It affects everyone – retail, hospitality, travel, hairdressers, dentists and the whole economy. Small business is under the pump and it will be difficult to offset some of the pressures because we just do not know how long the situation will persist.

Who knows whether it will be a V-, U-, W- or l-shaped recovery? I would be less likely to subscribe to a V-shaped recovery right now. We need to get the virus trajectory on track and the lockdown in place. Unfortunately, the cure is stifling growth in the economy.

EVANS We will see how China responds now it feels it has dealt with the peak of the shock. It will be interesting to see if there is a spectacular rebound in spending and confidence.

ONG The labour-market outlook, and the extent to which it deteriorates, is key. The worrying part is that the starting point for underemployment is high. There is already excess capacity in the market.

Unemployment will probably rise and stay high as we head into a recession and substantial downturn. The long-term unemployment rate will also rise in the next 12 months and this will be key for the economy. It will naturally temper the pace of recovery when we come out the other side.

Commonwealth and state governments are looking at the next package of stimulus. This is about how to provide support not just for the unemployed but to keep schools going and to keep training people. This will be important if the labour market is to pick up again at some point. We need the labour force to stay skilled and connected to the broader economy.

This will be a big challenge and it feeds into everything else we have talked about around confidence and sentiment.

Taking letters out of the recovery

An eventual economic recovery from COVID-19 may not even begin in 2020. Even when it does, the world may have profoundly changed.

DAVISON We have been saying for years that central banks would in all likelihood go into the next crisis with few bullets to deal with it. Looking ahead, how can the monetary and fiscal armoury ever be restocked? Should we assume that the recovery will inevitably involve another round of hollow asset-price inflation?

YETSENGA I am not sure we can have much confidence in the answer to this. These kinds of questions are incredibly important when it comes to what politics is going to look like coming out of this. I don’t think ‘populism’ is the right term, but we seem to use it a lot – and if we thought populism was high going into this, it is going to be much higher coming out given the way policy makers have handled this crisis in some countries.

If we are stuck at zero rates and QE for some period, we know it tends to encourage debt and the buyback of equity. Then the response is to protect business when there is a short, sharp shock – as we have seen offshore. We need to get through this crisis first, and it is looking worse as we go on, but the world afterwards is going to look quite different.

KangaNews is your source for the latest on the COVID-19 pandemic’s impact on Australasian debt capital markets. For complete coverage, click here.