Aussie QE will not fuel asset price bubbles

Christopher Joye

Coolabah Capital

In the AFR this weekend I write that the Reserve Bank of Australia has launched a new and entirely necessary monetary policy regime that will involve sustained quantitative easing (QE) to secure full employment and ensure that Australia’s trade-weighted exchange rate, and local economic conditions, are not adversely impacted by the much more aggressive asset purchases of central bank peers overseas. Click on that link to read the article. Excerpt enclosed:

In contrast to the government’s COVID-19 fiscal policy package, the RBA’s liquidity operations, and its circa $180 billion Term Funding Facility, QE is not a temporary stop-gap. With the RBA’s target overnight cash rate and 3-year government bond yields both at their effective lower bounds, purchases of 5- to 10-year Commonwealth and State government bonds to relieve upward pressure on our interest rates, which are the highest in the world among well-rated countries, and throw sand in the wheels of an exchange rate appreciating care of QE programs overseas, has emerged as the centre-piece of Martin Place’s monetary machine.

This makes a third, 6 month round of bond purchases, or QE3, a certainty in October, which is likely to be succeeded by QE4 next year and iterations thereafter. There is no reason to think the RBA will be minded to taper those purchases from its current $5 billion a week pace until it has high conviction it will achieve its goals, which will not be until 2022 or 2023. As Governor Phil Lowe’s protégé and putative successor, Deputy Governor Debelle, argued late last year: “In the situation we’re in at the moment, the right decision is to err on too much support rather than too little support”.

The board’s resolution on Tuesday to launch what we coined “QE2” with another $100 billion of bond purchases after QE1 expires in April, represented Lowe and Debelle functioning at their best. After decades working together through every imaginable crisis, they have matured into an agile, confident and adaptable team that rapidly absorbs external information and course-corrects as required. Here one should not understate the role of the RBA’s board, which has immensely experienced advisers, including Steve Kennedy, Catherine Tanna, and Mark Barnaba aiding and abetting.

While we had controversially forecast $100 billion of QE2 back in January, and expected clear signalling at this meeting, Lowe blindsided markets by committing, without hesitation, to a new program 4 months before QE1 expired. This was a deliberate effort by the RBA to pre-emptively eliminate any hint of “tapering”, which would have sent yields, and the Aussie dollar, soaring. (For what it is worth, Deutsche Bank assumed a reduced $75 billion commitment; NAB and JP Morgan argued they would taper to just $50 billion; and Capital Economics claimed there would be no more QE at all!)

Lowe also revealed that the RBA has learnt from past policymaking challenges, and is now ruthlessly focussed on delivering full employment and core inflation within its target 2 to 3 per cent band by kitchen-sinking its stimulus. In his public remarks, and through trusted media conduits, Lowe stressed that it is unacceptable for the RBA to have Australian workers labouring under the weakest wage growth in history when they need not do so, highlighting, as we’ve done, the 1.4 per cent nadir in the year to September.

Contrary to countless hysterical claims, propagated by those hunting click-bait, the RBA’s current QE program has no role to play in blowing asset price bubbles. As I have explained on many occasions, buying 5- to 10-year government bonds has no direct impact on local housing demand, and hence home values, because Aussies primarily use variable-rate loans that price off the overnight cash rate. Those that fix their mortgages do so for short terms of typically 3-years or less. Even when banks borrow longer-term funding, they swap it back to a floating-rate margin priced above the quarterly bank bill swap rate.

In his remarks during the week, Lowe highlighted, as this column has done on three occasions recently, that Aussie home values have not increased since mid 2017. Setting aside the fact that bank lending standards are the toughest they’ve been in decades, if irresponsible lending that promotes bubble-like conditions does emerge, APRA and the RBA will crush it via the “macro-prudential” constraints they’ve successfully applied in the past. This is precisely what gave us the 10 per cent correction in house prices between 2017 and 2019.

What makes the bubble-trouble talk ridiculous is that long-term Australian interest rates, and our dollar, have been increasing, not decreasing, in lock-step with moves around the world. The RBA’s mission with QE is simply to ensure Aussies are no worse off than our contemporaries overseas. In the counter-factual of no QE, the Aussie dollar would be trading with an 8-handle, smashing exporters and import-competing businesses, and long-term interest rates would be 30 basis points higher, according to Lowe’s testimony on Friday. We should be thanking Martin Place for sparing us this pain: in truth, there’s a credible case for the RBA to be doing a lot more QE than it is currently.

In his speech on Tuesday, Lowe laid out what is a very sobering challenge. Since the GFC the RBA has underestimated the degree of slack in the labour market. It thought full employment equated to a jobless rate of around 5 per cent, but relatively recently realised than the true number is much lower. This is one reason why it has failed to generate demand sufficient to lift wages growth back to the 3.5 to 4.0 per cent range required to get core inflation into the RBA’s target band.

The last time wages growth was on point was in the pre-GFC era when the jobless rate was bobbing around 4 per cent. Since the true non-accelerating inflation rate of unemployment (or “NAIRU”) is a non-observable, the RBA needs the economy to overheat. That means pile-driving the jobless rate down to the low 4 to high 3 percentage point territory where Martin Place can be confident that decent wages growth will materialise.

Beyond the precedent in the pre-GFC period, the new US Treasury Secretary, Janet Yellen, wrote the playbook on this in her prior role as chair of the Federal Reserve. At the time, she made it clear that the Fed was committed to smashing through the NAIRU, which was estimated to be 4.75 per cent, to resuscitate wages growth. The jobless rate duly fell to 3.5 per cent while US wages growth climbed back to 3.5 to 4.0 per cent.

If there is any doubt about the RBA’s mindset, readers should consult “Mini-McCrann”, aka The Australian Financial Review’s well-informed John Kehoe, who advised during the week that “money printing poised to be deployed for years to tackle the pre-pandemic challenge of weak wages growth, despite the brisk economic recovery”.

Kehoe highlighted the RBA’s “crucial pivot” to expressly tying the “doubling of the government bond buying program to $200 billion (with likely future extensions)” to the “outlook for jobs and inflation”. “So long as foreign central banks keep buying trillions of dollars of financial assets and put upward pressure on the Australian dollar, RBA quantitative easing could become a semi-permanent feature of the tool kit beyond this year,” Kehoe wrote.

This is why Kehoe believes that “QE III awaits”. “The thinking inside Martin Place now appears to be if it’s working and doing no obvious harm, why stop it?” That’s actually an understatement: beyond being surgically precise with scant collateral damage, the RBA’s QE program is making taxpayers $1 billion to $2 billion annually given that printing money costs it nothing.

Another RBA watcher, James Glynn, echoed these sentiments, asserting that “the decision to extend QE was a declaration by Lowe that no stone will be left unturned when it comes to exerting down force on the Australian dollar, and market participants should be seriously considering what it might mean for the second half of the year if the currency remains problematic”.

This is why we believe that QE3 and QE4 are lock.

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Christopher Joye
Portfolio Manager & Chief Investment Officer
Coolabah Capital

Chris co-founded Coolabah in 2011, which today runs over $8 billion with a team of 40 executives focussed on generating credit alpha from mispricings across fixed-income markets. In 2019, Chris was selected as one of FE fundinfo’s Top 10 “Alpha...

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