Our latest Complexity Premia podcast episode is now live (you can listen on your favourite podcast app, or you can find it on Apple Podcasts or Podbean). In this episode we discuss a range of issues, including the current market meltdown that is rapidly emulating aspects of the GFC and which will eventually present some once-in-a-generation buying opportunities:
- We discuss how COVID-19 is a classic case of global market failure driven by extreme information asymmetries, which I have repeatedly explained in my AFR columns over the last couple of weeks;
- How central banks need to move quickly to provide a liquidity bridge to keep markets functioning given investors are struggling to realistically price existential pandemic risks (again as outlined in my AFR columns of late);
- How the biggest risk is if central banks delay or under-club their response as lenders of last resort, which markets will punish, especially given they are rapidly depleting their prized credibility;
- Why the next subprime crisis will likely be triggered by subprime or high yield corporate bonds, which has been another key theme of ours for a while now; and
- Update on our views regarding the Australian residential property market, which we expect to remain strong.
In my latest AFR column (click here or AFR subs can click here), I argued that equity and debt markets were failing because investors were struggling to price, or handicap, the unknowable universe of risks inherent in a deadly pandemic that has the ability to paralyse global economic activity.
I argued the only tractable solution was for central banks and treasuries to move hastily to build a liquidity and stimulus “bridge” between now and that future juncture when vaccines and anti-viral drugs are widely available. While they have failed thus far to do this despite my repeated warnings that markets were failing weeks ago, the price action is going to force them to the table in fairly spectacular fashion.
Given the speed with which markets have been freezing, policymakers need to err on the side of generosity with their monetary and fiscal stimulus, knowing that it can be objectively withdrawn once the crisis passes. I've argued for weeks now that a key focus has to be on liquidity operations, and quantitative easing more specifically, which is needed much more than outright cash rate cuts.
Markets think there is a 113 per cent chance the RBA will cut rates next month (ie, more than one cut is being priced). In the meantime, the Fed, ECB and Bank of England all hold meetings in the coming days. A coordinated round of liquidity-boosting quantitative easing would help crush the extreme virus-induced volatility, which is destroying animal spirits and consumer and business sentiment. Indeed, this will probably prove to be one of the best buying opportunities we see in generations.
While the RBA might hit its effective lower bound of 0.25 per cent in April, it still has a massive arsenal of firepower at its disposal to help bridge the economic and liquidity gap between now and the mass distribution of anti-viral drugs and vaccines.
This obviously includes its own form of QE, which, as The Australian Financial Review's reporter John Kehoe has surmised, might involve announcing a specific target for the long-term interest rate on government bonds that represent the market’s best guess of where the future cash rate will be (plus a few other factors, such as compensation for future interest-rate risk). It could also be extended to providing liquidity against other very high-grade AA- and AAA rated securities that are already eligible for the RBA's repurchase facilities.
This will put downward pressure on the exchange rate, assisting affected industries, including tourism, education, exporters and other import-competing sectors. It will also keep the both the banks' and the government’s cost of borrowing low, supporting fiscal stimulus and maintaining the liquidity of the financial system.
At the limit, the RBA and APRA can ultimately control all market-determined borrowing rates if they feel the need to do so.
It is hard to know precisely when investors should be buying, as entry points are difficult to determine, but the time is likely nigh as markets force the hand of the central banks.
What we do know with certainty is that unlike the GFC, this is a very temporary shock, albeit a very deep one.
We will eventually get a vaccine, mostly likely within circa 12 months. We should also get an anti-viral drug from Gilead Sciences within a few months, which is currently in final phase randomised testing in China. The results of that testing should be known within weeks (the initial feedback is encouraging).
If that drug, which prevents the virus from replicating, can be mass-produced and distributed, it could materially lower fatality rates and precipitate a shift in global risk sentiment.
And then we have the summer months in the Northern Hemisphere to look forward to, which will likely slow-down infection rates (we still have no evidence of an uncontained outbreak in any warm climate).
During these dark days it is important to remember that light will eventually shine. Patience and resilience are likely to be rewarded in spades.
Could I maybe suggest that the property bulls should wait and watch for a few weeks before asserting that the property market is set to remain strong through this viral pandemic?. If we get tens of thousands of infections in one of the major cities, whose to know the flow on effect on property prices.