Market action hots up in anticipation of October 6th

Chief Economist's View

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This week, Australian fixed income markets lit up as seasoned Reserve Bank of Australia (RBA) watcher, Bill Evans, announced that the RBA will cut rates at their next Board meeting on October 6^th. The much-followed Evans’ change in rate call followed a speech by the RBA’s Deputy Governor Debelle, earlier in the week, articulating the RBA’s policy options going forward.

And, indeed, the list of options is long. They can lower the cash rate, the yield on 3-year government bonds and the rate they charge commercial banks for loans taken out from the RBA’s Term Funding Facility from 25 basis points (bps) to 10bps.

They can lower the rate they pay to commercial banks on reserves parked in the RBA’s Exchange Settlement Account from 10bps to 1bp. Finally, they can increase their purchases of longer-dated Australian and semi government bonds; most likely in the five-to-ten-year maturity range.

While it is not our view that Dr Debelle’s speech clearly indicated the RBA’s intent to act at their next meeting (in fact, the speech was an articulation of the Bank’s options regarding future possible policies and was almost a carbon copy of parts of Governor Lowe’s speech to the Anika Foundation back in July – and as we know the Bank did not change policies in August), an argument can be made for further policy stimulus to be announced on October 6^th. In particular, it would be a way of the RBA reinforcing the messaging that will come from the Federal government on budget day in a “Team Australia” display of unity between the Federal government’s fiscal policy and the RBA’s monetary policy in the co-ordinated effort to boost the economy and both business and consumer confidence.

It would also be good news for the Australian Treasury, as lower interest rates would certainly make their life easier. In fact, the day of the publication of Bill Evans’ rate call the Australian Office of Financial Management was about to issue $25 billion of Australian Government bonds. The subsequent fall in market interest rates (even though a mere 5bps) induced by Bill Evans’ rate call, was estimated by Jonathon Shapiro of the Australian Financial Review to have saved Treasury around $75 million.

Lower interest rates will also, hopefully, stimulate economic growth. Stronger growth increases the tax base of the economy and, therefore, Treasury’s revenues, which help offset the interest payments on higher debt levels.

This week also saw Federal Treasurer Frydenberg announce plans of significant infrastructure fiscal spending. Both Governor Lowe and Deputy Governor Debelle have been vocal in encouraging Federal and State governments to do more by way of infrastructure spending and fiscal stimulus in general.

For the RBA’s part, they have committed to keeping interest rates low so additional government debt is manageable into the future. But to date, private sector demand for government debt has been so strong, and hence interest rates have remained so low, that there has been little need for RBA intervention into the Australian Government bond market.

Finally, the week saw former Prime Minister Paul Keating pen a letter to the media accusing the RBA of conservatism, laziness and failing to do what is necessary to head off the worst of the coronavirus-induced economic crisis. So, what should the RBA be doing?

First, they would be well-advised to ignore Paul Keating’s attack. The RBA has clearly made a commitment to keep rates low; partly to reduce the costs of fiscal deficits. Nonetheless, the RBA needs to remain vigilant and a strong argument remains for the RBA to ramp up its purchases of Australian Government bonds beyond the 3-year yield that they are currently targeting.

Although most domestic private sector debt is held at the short end of the yield curve, the weighted average of the Australian Treasury’s bond issuance is 7.8 years, with significant holdings by foreign institutional investors. The 10-year yield remains at around 0.8%, so lowering that yield (apart from lowering the interest bill to Treasury) would also likely lower the AUD. As the economy reopens and as Australia’s bulk commodity prices begin to fall back to more sustainable levels, a lower AUD will help boost support of our traded goods and services sectors and help speed the recovery in the Australian economy.

Table 1: Financial market movements: 17 - 24 September 2020

Source: Bloomberg