Bears are underestimating policymakers at their own peril

Mark Todd

Bank of China

When commentators are asked about expected central bank behaviour, they generally fall even subconsciously between two camps, what the central banks should do and what they will do.

I think the more interesting question is what their goals are and how will it impact you either as an investor or as a market participant.

There are two strategies at play, fiscal stimulus and monetary policy. The key to fiscal stimulus isn’t the volume of money but the speed of distribution. Many critics worry about the debt load, and encumbrance on future generations; I would worry about the effectiveness of the distribution first. If it works, then we have a tax pie to distribute; if it doesn’t… well that’s an entirely more foreboding challenge.

The task for the political class of 2020 is to rise above the tribal ideological battles, set aside decades of internecine warfare and deliver bi-partisan actions. At the time of writing the media is reporting a delay in getting $1200 cheques to American households because the President wants his name on the cheque, so it might be a while before we see bi-partisan behaviour in some countries.

Which leads me to where there is genuine bipartisan conduct, the central banks. There is no evidence of uncertainty in their policy approach: buy everything! 

Start at the top and work your way down, which means providing funding via repo markets; banks lend their securities to the Reserve Bank of Australia (RBA) who provide funding. The funding for the banks in this format is 0.25% per annum and they can borrow billions at this level.

They’re prepared to go even further

If that doesn’t work, the RBA will broaden the scope of acceptable securities and lend against those.

To add to this, support the Australian Office of Financial Management (AOFM) will provide financial support for asset-backed securities, such as Australian mortgages, which reduces the cost of funding for Australia’s property market.

In the GFC the regulators worked to sustain the banking system, now they are working to reinvigorate the consumer and corporate sector. The experience of the GFC has made the RBA and all central banks match fit, as the crisis evolved, they flooded the system with cash, the AOFM stepped immediately to support asset back securities (mortgages).

What happens after a flood? The water, in this case money, slowly disperses. 

The RBA is the 900-pound gorilla and they will continue to flood the system until they see the impact on main street.

Banks are totally behind this approach; this is an opportunity to provide evidence they are ready-made to help society through this crisis.

What are the implications for investors?

Imagine if we have rates at these levels for years, until the weight of money has flowed throughout the system. The funding costs for ASX companies will be incredibly cheap, banks will have very limited issuance, not much stock for the hybrid investor, cash options like term deposits will struggle to be above 1%.

If there is a greatly reduced offering of conservative options, the money will flow into equities. I am of the view that equities, and especially quality companies, will be supported by incredibly low rates driven by central banks and should form a core part of a balanced portfolio.

We are in the midst of very tough times, but there are government agencies throwing extraordinary amounts of capital to put out every fire they can see. As we have seen in the recent bush fires, it’s not just extinguishing the flames it’s making sure there is no chance of reigniting.

That is the approach of our regulatory bodies, so I personally would make a plan based on their success, rather than fear of a depression or the traditional equity dogma. Buy good companies!

Investors I follow craft a top-down plan; macro, monetary policy, sector winners and relative value. On that basis, we are moving to less lock downs, monetary policy will be loose for years, sectors who have responded best to the changes in our working life such as tech, innovation, work from home, healthcare and others will continue to perform. Those that have suffered will be very slow to improve.

The relative value is more difficult to predict. Term deposits at 1%, active bond fund managers might get 4% if they are very good while property funds and equities are offering yields of above 5%.

In saying the above, investors should build a portfolio that can sustain volatility that is acceptable to them, if you are retiring Monday, you are a very different proposition to a person that has 20 years before they consider retiring.

Head of Fixed Income
Bank of China

Mark joined Bank of China in 2019 as Managing Director and Head of Fixed Income Sales, bringing with him over 25 years’ experience in FICC Sales. Prior to joining BOC, Mark was Head of Core Customers within NAB’s FICC Sales division.

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