RBA closer to getting out the cheque book as COVID-19 crisis deepens
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Before the bushfires and well before the coronavirus epidemic, economists and financial types were already speculating the Reserve Bank would need to backstop the Australian economy.
Now that markets have started on the biggest dive since 2008, the All Ords losing 6.3 per cent yesterday, and interest rates already at record lows, that speculation is ramping up.
The goal is to inject a lot of money into the economy that people will ultimately spend, thus greasing the country’s economic wheels.
The long-term impact of quantitative easing is to push up the demand for higher risk investments, such as equities.
But central banks can only do so much. They need governments to step in with the fiscal side.
The Liberal government on Monday promised a $10bn stimulus package and it has kissed goodbye a $5bn surplus, according to news reports.
RBA governor Philip Lowe said in November quantitative easing (QE) would become an option once the cash rate hit 0.25 per cent. He said his preference was for buying government bonds.
NAB economist Tapas Strickland says the RBA has one bullet left, a 25 basis point interest rate cut in April which will take the cash rate down to 0.25 per cent. That will decimate bank savings rates again, which is likely to further push depositors into riskier assets.
Strickland says the RBA will most likely use ‘Yield Curve Control’, which means it would set a target on the bond yield curve and only buy government bonds when it could no longer maintain that target.
“The end result would likely be an even flatter yield curve which could lower longer-end borrowing rates and perhaps risk premiums by reinforcing the commitment to keep the cash rate low for an extended period,” Strickland wrote in a note.
After the global financial crisis in 2008, the US government embarked on a bond, or debt, buying program. What this did was create demand for bonds, which then lowered the yield (a regular amount paid as ‘interest’).
Because investors were no longer getting a higher yield income, they were forced to switch into riskier assets such as stocks.
ASX investors are likely to be a direct beneficiary.
Janus Henderson portfolio manager Dan Siluk said in a note that an RBA bond buying program would “push investors toward riskier instruments such as high-yield debt and equities, creating more favourable financing conditions for those entities”.
Some commentators and economists have been pointing to a global downturn for some time and the coronavirus epidemic is likely to be the trigger.
Globally, economies were looking ok — not great, just ok — at the end of 2019.
But coronavirus, or COVID-19 as it’s officially called, caused a 20 per cent drop in demand for oil by the world’s biggest oil user, China, and supply chain disruptions stemming from that country began to ripple around the world, and demand has been destroyed.
OPEC’s meeting over the weekend sought to combat the subsequent price fall with further production cuts, but Russia — a friend to the cartel rather than being in it — said it would no longer participate in new cuts. So Saudi Arabia said they too wouldn’t participate.
Oil prices are down about 25 per cent, touching levels around $US30 ($46) last seen during the oil price crash in 2014.
That fed a downwards spiral on Monday.
The ASX Small Ords was down 7 per cent by the end of Monday, the Australian VIX index — a measure of market volatility — hit levels not seen since 2016, and the Australian dollar slumped almost 5 per cent against the US currency.
The corporate debt market is now looking shaky, with ratings downgrades on the cards.
Societe Generale SA head of fixed-income research Guy Stear wrote in a note that “there are signs of stress in almost every corner of financial markets”.
Yields on US benchmark 10-year Treasury Bills, or US government bonds, plunged after the Federal Reserve made an emergency rates cut last week, dropping the federal funds rate by 50 basis points to in the 1 per cent to 1.25 per cent band.
While shorter dated bills have gone into negative territory in the past, the longer dated ones have not.
That is worrying investors in the riskier corporate debt market.
The US corporate bond market alone is worth $US10tn or five times more than in 2001, according to Blackrock.
Scott Shuttleworth at Vega Capital last year wrote on Livewire that much of this debt is at the riskier end of the spectrum, as companies have used lower rates to load up on loans.
With warnings from all quarters including Schroeder’s, the Bank of International Settlements, the International Monetary Fund, and PIMCO over the last couple of years about the quality of global corporate debt available, the coronavirus crisis could be the catalyst for a corporate bond crash, as liquidity and demand is squeezed.