Throughout Australia’s emergence from the pandemic, the RBA has remained steadfast on its outlook for interest rates – no rate hikes until 2024.
But as UBS researchers pointed out this week, the post-COVID global economic rebound “has been faster than any time in history”.
In turn, investors are betting “the monetary policy cycle will also be faster”.
Markets are now pricing for around 70 basis points (0.7%) of hikes by the end of 2022.
That’s a fair bit earlier than 2024, and raises the question of what the RBA will do next.
The unwind — step 1
Before any rate rises, economists are turning their attention to the first phase of the RBA’s unwinding plans; the roll back of its bond-purchasing (QE) program.
In the wake of the east coast Delta lockdowns, the bank extended its monthly bond-buying program through to “at least February (2022)”.
But in UBS’ view, markets are still being “too complacent” about possible changes to the program.
The UBS analysts’ base case is for the bond-purchase program to be halved in February — from $4bn per month to $2bn — before stopping in May.
However, “we see a risk that the bank may opt for an earlier hard-stop of QE at the February meeting”, UBS said.
At that point, the central bank will own around 35% of all Australian government bonds outstanding.
Such a stake is starting to skirt the edges of an RBA-influenced paradigm that could disrupt the orderly functioning of the bond market, UBS said.
The RBA will also take its monetary policy cues from offshore.
Most commonly in central banking, all roads lead to the US Fed — which has flagged plans to start tapering its own QE program in November.
“We think the RBA will be uncomfortable owning such a large share of the market; especially if global central banks have started the taper (or even stopped),” UBS said.
The unwind — step 2
Next up is what the RBA will choose to do with its yield-curve control (YCC) program.
Currently, the YCC anchors three-year government bond yields at the same level as benchmark interest rates (0.1%).
Recall that markets are pricing for rate hikes as early as 2022.
Such a scenario would create a “policy difficulty”, CBA strategist Phillip Brown said this week, in terms of what the RBA does with its YCC program.
In response, markets sent the yield on government bonds with a maturity date of April 2024 to almost 0.2% this week.
Then the RBA turned heads on Friday, when it waded back into the market and bought $1bn of Apr-24 bonds in a range between 0.105% to 0.12%.
Brown and CBA rates strategist Martin Whetton also drew attention to an inflation reference in a speech this morning from RBA Governor Philip Lowe.
“Whether inflation in a given year is 1.7% or 2.3%, most people in the real economy rightly don’t focus too much on this,” Lowe said.
His remarks suggest the RBA remains “relatively indifferent to inflation risk”, Whetton and Brown said.
And combined with the RBA’s YCC bond acquisition today — its first since February 26 — “neither action was one that suggests the RBA is about to about-face on policy”, the pair added.
At the same time, they noted that today’s bond purchases didn’t do much to change the market’s mind about the pace of future rate hikes:
So for now, the standoff continues as markets price in 2022 rate increases while the RBA looks to be holding firm to its 2024 stance.
In his analysis earlier this week, Brown said there are a couple of technical options the RBA could take on the YCC program, such as bringing it into a range (rather than a fixed number).
But realistically, if the RBA is going to raise rates in 2022 or 2023, it will most probably have to abolish the YCC program on 2024 government bonds, Brown said.
When’s the best time to do that? Either late-2022 or early-2023, Brown said.
That’s because Apr-24 bonds will still have a maturity date of more than 12 months — meaning they will still trade in the bond market and not short-term cash markets.
Of course, the next best time to do it would be “right now”, Brown said.
But that looks unlikely, given the bank’s recent commentary.
And perhaps even more unlikely following Friday’s purchases in the bond market.