RBA sailing on global currents
The Reserve Bank of Australia (RBA) has some capacity to taper or even withdraw stimulus measures over time. Ultimately, though, it will likely not be able to go fully in one direction if its international counterparts are heading in another.
MCCOLOUGH If the RBA is targeting the currency the litmus test would be what would happen if QE were removed tomorrow. Given all the other influences on the currency, we know it would move significantly higher. Therefore, the simple answer is yes: the RBA is locked in while the other central banks maintain QE.
We are forecasting tapering in QE3, with purchases down to A$50 billion (US$39.1 billion). However, this has large risks to the upside.
The RBA will be looking at the volume it owns in any individual bond line and whether it is creating bottlenecks or shifting investor behaviour in the market. This is likely to become more of a problem with QE3, if it is indeed extended.
WHETTON On bottlenecks, one observation we made a few months ago was that in Japan the 10-year cash bond does not trade anymore.
The RBA is talking about owning 20 per cent of the market rather than 40 or 60 per cent. But if bond-purchase programmes are large enough that they take away liquidity, and there is reliance on the central bank being the backstop bid for extra supply, we may see a dysfunctional market.
This is not good in the medium and longer term for issuers coming to market, because they cannot get proper price discovery or tension. The market may become centred around new issues, where investors will be keen to participate for the new-issue concession. But overall the withdrawal of liquidity can cause dysfunction.
CROMPTON I think the semi-government market is already at risk of heading in this direction. On this point, the RBNZ [Reserve Bank of New Zealand]’s programme has some merit. It was one of the most aggressive QE programmes in the world when it launched but its targets are much more flexible.
RBNZ purchases are expected to finish in mid-2022 at the moment, and it has straightforward caps on what it can buy. New Zealand Debt Management has been in the fortunate position of having reduced issuance since the height of the pandemic. But the RBNZ has been able to taper along with this and is now outright tapering.
The RBNZ did not go for rigid buying targets, and there are pros and cons either way. But its programme can react more flexibly to changes, whereas the RBA is committed to A$5 billion of purchases per week now.
The RBA is talking about owning 20 per cent of the market rather than 40 or 60 per cent. But if bond-purchase programmes are large enough that they take away liquidity, and there is a reliance on the central bank being the backstop bid for extra supply, we may see a dysfunctional market.
PLANK It would make it quite difficult for the RBA to communicate what it is doing. New Zealand had a 40 basis points sell off in its 10-year bond over the space of five days and I am not sure this is the route the RBA would want to take.
Looking at the impact of QE, studies show the signalling aspect is probably more important than anything else. If a central bank is dynamic with a programme that goes up and down, the market potentially does not know what is happening. It can create confusion.
WHETTON We could absolutely get some volatility. It is not something we have looked into much because we think tapering is a long way from happening. Many factors that would determine this are just not being communicated yet.
One story is that by the time the RBA is thinking about reducing its commitment to the market, we will be in a period when the AOFM [Australian Office of Financial Management] and the semi-government borrowers have much less to issue, and the committed-liquidity facility reduction will be kicking further into gear – so demand should still equalise with supply.
Whether we have a cash rate that is much lower than other markets will also be a factor. If we are lower and foreign investors can find more attractive yield elsewhere, we might see a wholesale move out of our market to other options. This could create volatility.
One thing we can probably agree on is that, if and when the RBA starts to hike rates, it will be at a very slow pace. There is a limit to how far the three-, five- and 10-year parts of the curve move from the cash rate.
MCCOLOUGH We also have not looked too much into tapering given it is so far away. But the real message from the taper tantrum is that the direction needs to be credible according to where the economy is placed. This goes back to the RBA wanting to see actual outcomes in inflation, growth and unemployment.
If the market does not think it is credible, the question I would have is whether the volatility is because it is the RBA that is doing all the heavy lifting with support for the market. If this is the case, the reserve bank has either done too much or removed support too soon.
I think the market will show natural progression from a fundamental economics point of view – and this will provide the signal.