Weekly Insights BY THE CURVE TEAM –

Weekly Insights: A New Paradigm

23rd of August, 2021

Key Updates

  • Monday – Australian Services and Manufacturing PMI updates
  • Tuesday – Weekly Consumer sentiment survey
  • Wednesday – Construction Work Completed for Q2 (first partial GDP indictor)
  • Thursday – Latest CAPEX update and Weekly Payrolls
  • Friday – Retail sales (July Preliminary)

A New Paradigm

The RBA Minutes for the August meeting showed a stance that was a sharp juxtaposition to 2020. They opted to not provide looser policy in the wake of covid induced lockdowns, saying that ‘fiscal policy is a more appropriate instrument than monetary policy for providing support in response to a temporary, localised reduction in incomes’.

This contrasts with last year, when the RBA successively eased policy despite enormous fiscal stimulus, namely from JobKeeper, JobSeeker and HomeBuilder. In March, it resulted in the cash rate falling to 0.25%, a yield curve target on the 3-year Australian government bond and the introduction of the Term Funding Facility (TFF). In September, the TFF was expanded and in November QE was implemented and the cash rate, TFF rate and yield curve target all reduced to 0.10%.

What has changed so the RBA deems looser policy unnecessary? The RBA’s decisions in 2020 have continued to have an impact in 2021 to the point where a completely new paradigm exists. Consider:

  • Surplus Exchange Settlement Balances, which hovered around $2-3 billion pre covid are now at $362 billion. The TFF and QE, all introduced in 2020, continue to see these balances grow.
  • Daily market operations, which used to be the RBA’s bread and butter for achieving the target cash rate, is largely irrelevant to monetary policy. The surplus liquidity has driven the cash rate to 0.03%, and daily market operations will mature on Wednesday’s only as of September, so will only be relevant for one day of the week!

The RBA could have pumped more liquidity in the system by committing to more government bond purchases, but the marginal effect would be minimal. If you take surplus ES balances from an already enormous $362 billion to $450 billion, how much difference can it really make?

They could have re-introduced the Term Funding Facility, but if ADIs are already hoarding billions, then having more cheap money won’t amount to loans being written. The RBA have supported the economy to the point where they have completely shifted the paradigm of the monetary system.

Investing Ramifications

We hesitate to say ‘this time is different’ but at the very least we need to acknowledge there are significant differences to pre covid. Until the excess liquidity is drained from the system:

  • Rates relative to BBSW and the cash rate target are unlikely to return to pre covid levels.
  • The actual cash rate is not guaranteed to meet the RBA’s target, given open market operations are much less significant.

The cash rate target can go up because the rate the  RBA offers on ES balances sets a floor for the cash rate. However, the impact of excess liquidity will continue to have downward pressure on rates.

A return to a pre covid paradigm is more likely when:

  • The TFF matures, the bulk of which is in September 2023 and June 2024. This will reduce excess liquidity by around $180 billion (the amount borrowed by ADIs using the TFF).
  • When RBA bond purchases either mature or are sold.

Without meaning to keep flogging a dead horse, this outlook lends itself to barbell strategies and being comfortable investing for longer tenors, even if only a small portion of the portfolio.

Josh Stewart

Associate - Money Markets