–  February 2021 INSIGHTS BY THE CURVE TEAM –

Highlights

  • Two key government programs – JobKeeper and HomeBuilder ended as of March 31.
  • The economy is expected to hold up in spite of this.
  • Employment in particular continues to overdeliver, with the economy having regained all the jobs lost during Covid.
  • Other variables, namely dwelling approvals and lending may face headwinds ahead.
  • More consequential will be where these levels normalise, as this will indicate what economic activity is sustainable.

Rates Recap

  • The imminent end of the TFF is leading to banks making the most of cheap funding by coming to market with new issues.
  • The yield curve target being extended to the November bond is the next looming deadline.
  • Although market pricing implies the target will not be extended, the economic and market data will have to be resoundingly positive to justify ending the target.
  • To prevent runaway house prices while monetary policy is so lax, macro-prudential reform will be considered over the months ahead.

Key Policy Deadlines Arrive

April marks a key turning point for the economy as government support is wound back significantly. In particular, two key government programs ended as of 31 March. The first was JobKeeper, which at one point had over 3.5 million employees receiving the payment. The second was the HomeBuilder scheme, which had over 75,000 applications by January.

Both have played a major role in economic activity over the past 12 months. Unemployment, initially expected to surpass 10%, instead peaked at 7.5% in July. Dwelling approvals, which were expected to stagnate, have risen over 20% for the year. Income support and low rates have helped insulate property price declines.

The transition from an economy reliant on government support to one which is driven by consumers and businesses was alluded to in the February monthly insights. The second quarter of the calendar year will provide a clearer picture of the state of the economy without government support. Compared to the start of the year, we have more clarity on how the economy will fare without the government programs.

Employment especially has continuously overdelivered since the depths of covid, which should mitigate the impact of the end of JobKeeper. Unemployment is currently 5.8% and there are more people employed than pre-covid. This is in contrast to RBA expectations, which predicted an unemployment rate of 6% at the end of the year.

March employment data is yet to be released, but another 35,000 people are expected to be employed which would take the unemployment rate to 5.7%. This would leave the labour force in very good stead prior to the end of JobKeeper. Those employed but working zero hours is being used as a metric to gauge the impact the end of JobKeeper will have.

As of February, there were nearly 107,000 people employed but working zero hours. By contrast, in 2019, there were on average 55,000 people employed but working zero hours. Using this simple comparison would imply that there will be at least some hit to employment from JobKeeper ending. However, the momentum in the labour market will likely offset a lot of the jobs lost.

The strength of the labour market is critical to the economic recovery being sustained. It will ensure people have disposable incomes to support consumption. It also poses the most viable means for inflation to return. Although transient inflation is expected as prices rise off covid lows, wage pressure from low unemployment is viewed by the RBA as the key metric required for inflation to sustainably reach the 2-3% target band.

Despite the positive outlook for employment, it is less clear how other economic variables will hold up over the second quarter and beyond. Dwelling approvals will very likely fall from lofty heights now that the HomeBuilder program has ended. This may have implications for the broader housing market including housing finance, which is up 55.2% on last year.

A decline in these variables would indicate a slowdown in economic activity but is not necessarily a bad thing. Current levels for dwelling and finance approvals are arguably unsustainable and clearly elevated by government programs. More relevant is where they normalise.

There are enough indicators suggesting activity won’t simply fall off a cliff now that HomeBuilder and JobSeeker are gone. Employment is the primary one. Consumer and business confidence are another. Both are at very high levels, which increases the likelihood that consumption and investment will be sustained.

The final hurdle for the economy’s normalisation is the opening of international travel and borders. Only when these are fully opened will a fair comparison to pre-covid levels be available.

Progress on vaccinations is crucial to borders re-opening. Over March there were some hurdles with the AstraZeneca vaccine. Australia has disallowed its use for those under 50, which followed similar moves by other countries, namely in Europe. Even without this decision, the vaccine rollout in Australia has been slower than initial targets.

Nonetheless, the beginning of the vaccine rollout alludes to what is possible. The US has over 20% of the population fully vaccinated and the UK has over 10% (with a very large portion of the population having received one dose already) with more vaccines currently being trialled. Even with vaccine distribution being slower in Australia, a travel bubble between New Zealand and Australia is now in place.

To summarise, the end of government programs will be more a formality in transitioning away from government led growth. Rather than it marking an imminent drop in economic activity, it will mark the first phase in determining sustainable levels of economic activity.

Outlook for Interest Rates

Similar to the economy, the rates outlook is highly dependent on imminent monetary policy deadlines. This first looming deadline is the Term Funding Facility, which expires at the end of June.

Rates are expected to remain subdued at least until this expires. However, there is evidence of bond activity to take advantage of the low rates. Multiple banks have issued medium term notes at very low levels in recent weeks. This is in spite of liquidity levels remaining extremely elevated, so suggests that banks are taking advantage of the cheap funding while it is here, even if they do not imminently need it.

Beyond the TFF will be the decision to move the three-year government bond target of 0.10% to the November 2024 bond from the April 2024 bond. It is likely at this stage that the RBA will make a decision on this in August. Market pricing implies that the RBA will not switch to the April bond. Multiple factors are contributing to this.

Employment is the first. It is running well ahead of RBA expectations. Since the start of the pandemic, the RBA have placed a newfound importance on employment, describing it as a national priority.

The Australian dollar is another factor. At one stage it threatened to break through 80 cents against the US but has since eased back towards 76 cents. An appreciating dollar was a primary motivator for the RBA to introduce QE at the end of last year, so with the dollar easing there is less impetus to maintain these policies. However, other central banks continue to run enormous QE programmes, which makes it hard to justify removing the yield curve target and QE because by removing them it will almost certainly put upward pressure on the dollar that wouldn’t otherwise be there.

Inflation is less certain. The RBA forecasts inflation of 3% in the June quarter. If this overdelivers then there will be a strong case to not extend the yield curve target to the November bond. Should it underdeliver, then the RBA will face a tricky decision. Should it prioritise its inflation target or emphasise the signal from the labour force.

There is also another factor, which is the RBA’s forward guidance. If they err to removing the target, then their credibility will come into question. When they have constantly stated they will keep policy loose until the economy is firmly back on the path to recovery, it would seem contradictory to tighten policy in the face of mixed economic data.

With this in mind, unequivocally positive economic data will likely be needed to justify removing the target. Employment is already showing sufficient evidence of this. Inflation will be the next piece in the puzzle. If overseas central banks also begin unwinding their QE programmes, then things should align to remove the target.

This will be consequential to rates. Currently, investors are having to go beyond 3 years to find yield. It is making for a flat curve out to three years but a steeper one beyond three years. If the target were removed, a normalising of the yield curve would likely ensue, which would translate to higher rates available at shorter tenors. However, because the RBA will maintain the 0.10% target on the April bond, the normalising of the curve will not be instantaneous.

Beyond the 3-year target, QE will be the next policy in the firing line. Very similar forces will affect the RBA’s decision on whether to extend or end QE. To justify ending both the three-year target and QE over a short space of time would require a remarkably strong economy, to the point where it is hard to imagine a sudden unwinding of both.

Becoming more relevant to the RBA is house prices. As discussed, the RBA will be reluctant to remove the three-year target and QE with haste, which will continue to put upward pressure on house prices. Rather than factor this in to determining whether to ease policy, the RBA have instead indicated they will be ‘monitoring trends in housing borrowing carefully and it is important that lending standards are maintained’. This implies that macro-prudential reform to prevent runaway house prices could be a means to maintaining such lax monetary policy.

Australian Economic Highlights

  • Growth in Australia continues to rebound into the end of the year positing a second consecutive increase above 3% in the Q4. The recovery in growth continues to be driven by consumption, which was also the hardest hit component of growth during the Covid downturn. GDP is expected to return to pre-Covid levels by the middle of the year and grow by 3 ½ per cent in 2021 and 2022.
  • Inflation continued to recover over Q4, up 0.9%, which was the same read for the annual rate. Childcare continued to be an outsized factor following the unwinding of free childcare. Inflation will be coming off a low base so may appear high in the near term, but sustained upward pressure is still a way off given the RBA’s forecasts for unemployment.
  • Employment continued its remarkable recovery with a gain of nearly 89,000 jobs, with the bulk of them full time jobs. This was well above expectations again and leaves employment higher than pre covid. The unemployment rate is now 5.8%, higher than the RBA would like and may face headwinds as JobKeeper ended at the end of March.
  • The ANZ Job ads continue to follow employment growth, up another 7.4% in February after a revised gain of 8.8% in February. They are now 23% higher than pre covid levels.
  • Business confidence and conditions remain at elevated levels. Conditions have hit a new record for the index, up 8 points in March to be 25. The employment index was particularly strong, up 7 points to 16, which bodes well for the end of JobKeeper. Confidence was down 3 points but remains very high at 15.
  • Consumer confidence increased again, up 2.6% for March to be 111.8. Gains were broad based across the index, which bodes well for the likelihood that consumers will spend their high levels of savings.
  • Retail sales eased over February, down 0.8%. Lockdowns in WA and Victoria acutely effected spending, with sales falling in WA and Victoria 5.4% and 3% respectively. Sales are still well above pre-covid levels.
  • There was a change in trajectory for housing finance approvals, down 0.4% for February following a 10.5% gain in January. Approvals are still up 55.2% for the year, so a slight fall on January levels still amounts to a large gain in approvals. Where owner occupied loans have dominated the growth, which likely links to the HomeBuilder grants, investor loans dominated the month, up 4.5%. Should the end of the HomeBuilder scheme limit owner occupied loans then this trend may continue.
  • Australia’s trade surplus pared back over March following a record in February. The surplus dropped to $7.5 billion from a revised $9.6 billion. Exports were down 1% from commodity falls and imports were up 5%, which reflects a pick-up in domestic demand.
  • The imminent end of the HomeBuilder scheme which still had grants of $15 000 available in February saw a strong bounce back in building approvals in February. Following a 19.4% drop in approvals in January, they bounced 21.4%. Private detached housing approvals were up 15.1% over the period which follows the strong gains in loan approvals for first home buyers.

Josh Stewart

Associate - Money Markets