–  OCTOBER 2020 INSIGHTS BY THE CURVE TEAM –

Highlights

  • The government finally delivered a budget update full of incentives but light on spending.
  • More monetary policy is expected to compliment the latest fiscal policy announcements.
  • A lift in confidence from businesses and households is needed for the current monetary and fiscal settings to have their full effect.
  • However there are a number of uncertainties that pose a significant threat to the outlook and the recovery that is expected to be “bumpy and uneven”.

Rates Recap

  • The RBA left the overall setting of monetary policy unchanged at their October board meeting.

  • Following the extension and expansion of the TFF program, the RBA has so far left the cash rate target and rate payable on Exchange Settlement balances at the reserve bank unchanged at 0.25% and 0.1% respectively.
  • In the accompanying statement to their October meeting, the RBA confirmed that they stand ready to do more if required to assist with Australia’s recovery from the pandemic. The statement, along with a recent speech from Deputy governor Guy Debelle has the market expecting more policy action at the November board meeting.
  • Expectations of further policy action has seen Australia’s yield curve continue to flatten. Interest rate futures are suggesting the cash rate could fall while bond futures suggest that a lowering of the yield curve target could be coming.
  • Despite further policy action being priced in by markets, the AUD continues to hold its ground above 0.70. This is largely in part to persistent weakness in the USD. 

  • The Australian yield curve has also decoupled from moves in the US yield curve. We have seen a noticeable steepening of the yield curve in the US over past month.

Lingering Uncertainty A Threat to the Recovery

Victoria is now getting on top of the second wave of Covid-19 infections. NSW has managed to avoid a full blow second wave thanks to the diligence of health authorities. The Federal Government has handed down its highly anticipated and significantly delayed budget update. The RBA has and will continue to ensure cheap funding will remain readily available to support the economy. It is time for the recovery.

But what will the recovery look like?

In his statement accompanying their recent board meeting, Governor Lowe probably said it best, saying:

“The national recovery is likely to be bumpy and uneven and it will be some time before the level of output returns to its end 2019 level.” 

Following the RBA’s most recent meeting and the release of the budget from the Government, we know with a greater degree of certainty what the policy landscape is likely to look for the next stage of the recovery.

Current monetary policy settings are ensuring that there is plenty of low cost funding available from the banks to support lending. That is being achieved by the structure of interest rates and the Term Funding Facility. The RBA continues to indicate that they will adjust these mechanisms  to ensure that monetary policy supports the recovery.

Similarly, the latest budget update from the government has fiscal policy also aiming to provide an environment that will be supportive of an economic recovery. In the budget there were plenty of incentives and support mechanisms available to businesses along with tax cuts to give consumers a little more in their pockets. There was some focus on government infrastructure spending being pulled forward but more could have been done.

So what we have is a policy environment that will support the economic recovery, based on the assumption that businesses and consumers take advantage of these policy settings. Crucial to the effectiveness of the current policy settings in achieving a solid recovery is confidence. With so much uncertainty, that could be something hard to come by.

There is good reason for the RBA to characterise the recovery as likely to be “bumpy and uneven” and in one word it is ‘uncertainty’. Despite policy settings now being widely know, there is still so much uncertainty over the outlook. Unfortunately uncertainty is the kryptonite of confidence.

The list of uncertainty consists of but is not limited to:

  • The scaling back and eventful winding up of the Jobkeeper and the Jobseeker supplement
  • The pending conclusion of loan deferrals over the coming months
  • The moratorium on insolvencies coming to an end
  • The timeline for domestic borders reopening
  • The timeline for international borders reopening
  • Another large scale wave of virus infections and subsequent restrictions used to get it back under control

Many of these uncertainties will have their own impacts on the actual level of activity. More importantly, while they exists, they are likely to undermine confidence amongst both businesses and households. Without confidence, the current monetary and fiscal policy settings alone are unlikely to spur a robust recovery.

Unfortunately there is no silver bullet that can solve the situation. Restoring confidence is likely to take time. The longer it takes, the greater the likelihood that we will need to see more policy action, especially from the government, to support the economy until a self sustaining recovery can be achieved.

Outlook for Interest Rates

Following the RBA’s decision to extend and expand the Term Funding Facility at their September Board meeting, the market is anticipating further action. The growing expectations of further support from monetary policy were driven by two key events.

The first was a speech by Deputy Governor Guy Debelle who spoke to the Australian Industry Group’s September 22 virtual conference. After providing historical context for the current decline in output both domestically and internationally, then outlining how monetary policy works, he focused on what more the RBA could do if required.

These policy options have largely been covered previously by the RBA and include:

  • buy bonds further out along the curve, supplementing the three-year yield target
  • foreign exchange intervention
  • lowering the current structure of rates in the economy a little more without going into negative territory
  • negative rates

The fact that so much detail was given sparked expectations that further easing on the back of the Term Funding Facility changes in September would be forthcoming at the October meeting.

Expectations of what action would be taken focused on the changing of the current rates structure in the economy. This could include a change to the cash rate, the rate paid on Exchange Settlement Account balances with the RBA, the 3 year yield curve target of 0.25% or the Term Funding Facility rate of 0.25%. The other most likely policy change could be purchases of bonds further out the curve.

Intervention in foreign exchange markets seems unlikely given the RBA’s doubts over how effective that would be. Negative rates are also seen as very unlikely given there is no clear evidence that going negative works over the long term.

At their October meeting, the RBA elected to leave the current settings unchanged. However, they left the door open for further policy action. The final sentence to their statement said:

“The Board continues to consider how additional monetary easing could support jobs as the economy opens up further.”

It seem inevitable that the RBA will try to do more to support the economy and achieve its mandate. Their own forecasts suggest it will take years to get inflation back in the target band and the economy back to full employment. Those forecasts also have very little wiggle room given they are somewhat optimistic.

The only question that remains is what tool they will choose to use next and when they will choose to use it.

Australian Economic Highlights

  • As was expected Growth slowed sharply in the second quarter. Economic activity fell by 7% over the quarter with a 12% fall in household consumption accounting for the bulk of the decline. The outcome pushes the economy into a technical recession for the first time in almost 30 years.
  • Inflation fell heavily in the second quarter as was widely expected. The headline inflation index was down 1.9% taking the annual rate to -0.3%, the first annual fall in prices since the Asian crisis in the late 90s. The only other negative read was in the early 60s. The trimmed mean was also negative, falling 0.1% over the quarter with the annual rate slowing to 1.2%. Inflation is expected to bounce back in Q3 as one-off impacts are reversed.
  • The Employment data once again beat expectations with total jobs growing by 111,000 after a fall of 35,000 was expected. The participation rate unexpectedly rose but it wasn’t enough to offset the impact of new jobs on the unemployment rate, which fell 0.7% to 6.5%. The true nature of the employment market is likely to reveal itself over the coming months as government support mechanisms are slowly wound back.
  • The ANZ Job ads report indicated that the rebound in jobs got back on track, with ads growing by 7.8% in September after stalling in August. Jobs ads still remain well below the pre-pandemic levels.
  • Business confidence improved a touch in September rising from -8 to -4 . Business conditions also showed some improvement with a pickup across all the sub-components pushing the index up from -6 to 0.  The employment index remains a concern sitting at -6.
  • Consumer confidence rebounded strongly in September after the deteriorating situation saw confidence collapse in August. Near term expectations for the economy was the biggest driver over the month as all subcomponents improved. A drop in the unemployment expectations index was also a welcome development.
  • After being a large beneficiary of government support measures, Retail sales stalled in August as impact from government stimulus measures waned. Total sales were down 4% over the month. Consumption more broadly remains a little weaker than total retail sales figures suggest.
  • New housing finance continues to rebound as banks get back on top of loan processing times. Total housing finance improved sharply in August and September as a result with owner occupiers, including first home owners driving the bounce in new approvals.
  • Australia’s trade surplus continued to fall in August after a sharp decline in July. On the upside imports are improving, rising 2%, which suggests domestic demand is slowly picking up. Meanwhile exports, especially to countries excluding China, fell for a second month. Total exports were down 4% leaving the trade balance at $2.6bln. If the trend continues, net exports will detract from growth in Q3.
  • After a volatile few months, Building approvals were relatively unchanged in August, posting a 1.6% fall. Within the data, private housing approvals continue to benefit from government policy, rising 4.8%, while multi-unit approvals declined.
David Flanagan

David Flanagan

Director Interest Rate Markets