Coronavirus special podcast episode

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need to err on the side of generosity with their monetary and fiscal stimulus, knowing that it can be objectively withdrawn once the crisis passes.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.