Macro

This weekend I write that the ECB's decision to start buying bonds again to reduce the long-term cost of capital (aka QE)---coupled with the Fed cutting in a few days---will only amplify pressure on the RBA to follow-suit (click on that link or AFR subs can click here). I also argue that it is high time APRA considered increasing the Australian banks' counter-cyclical capital buffer (CCB), which has curiously never been above zero even though it should be, on average, positive through the cycle, as we move into the first phase of the next housing boom. This latter observation was coincidentally timed with a new speech from APRA's Wayne Byres in which he stressed the importance of ongoing vigilance to mitigate financial stability risks at a juncture when the pendulum has swung in favour of focusing on more qualitative cultural and governance failings. I am frankly much more interested in reducing the probability of banks blowing up than these other subjective matters that have consumed so much attention of late, and I sometimes worry that all the attention paid to culture and governance will distract APRA from its core legislated mission of protecting bank creditors. While a belated and inaugural increase in the CCB to a non-zero level will not win me many friends amongst bank shareholders and executives, depositors should cheer the development! Excerpt enclosed:

Our central case has been that both the ECB and the Fed would cut rates in September, which was a consensus view, and, more controversially, that ECB President Mario Draghi would re-start quantitative easing (QE), or buying bonds.

It was clear that a lot of smart money did not agree with our September QE thesis with repeated reports that a QE package had been canvassed and rejected by key ECB governors.

Following Draghi’s announcement on Thursday of a package of stimulatory measures, including a cash rate cut, extended direct loans to banks, and a new EUR20 billion per month bond buying program that surprised with no terminal date (it is completely open-ended), Bloomberg claimed there was an “unprecedented revolt” during the meeting with representatives from France, Germany and the Netherlands pushing back against Draghi’s desire to re-start QE.

The result was an immediate risk rally, with credit spreads crunching tighter and equities jumping. This positive shift in the zeitgeist has been aided by yet another rapprochement in the US-China trade dispute with chatter suggesting there might be a partial deal struck in October to cauterise further economic pain as Trump progresses towards the 2020 election...

While the developed world crushes the global cost of capital, the Aussie dollar has continued its recent ascent from as low as US66 cents earlier in the month towards US69 cents at the time of writing. This will presumably continue if the Fed delivers with a dovish rate cut this month, ramping up pressure on the RBA to follow suit given its goal of reducing the jobless rate to below 4.5 per cent and lifting inflation back to its target 2 per cent to 3 per cent band.

The RBA’s deputy governor, Guy Debelle, has made it clear Martin Place would like to see the currency lower, and governor Phil Lowe appears increasingly comfortable with the idea that the central bank may have to launch its own QE initiative to assist with this cause.

In this context, the chair of the house of representative’s standing committee on economics, Tim Wilson, is doing a fine job of holding the RBA to account. In a detailed set of 61 questions interrogating the RBA’s recent submission to parliament, Wilson asked whether the “RBA completed any analysis or modelling on the wealth transfer effects of QE between either the young or the old and/or those with assets and those without assets?”

The RBA referred Wilson to three global studies on the subject, the general conclusion of which was that “the first-order effect of QE is to increase incomes for households who would otherwise be unemployed”.

“In Australia as well as in those other countries, the households that benefit most from lower unemployment are young, low-income and have few assets,” the RBA continued. “Asset prices are also supported by this policy, but the effect of this on asset-owners’ incomes and wealth is smaller than the effect of reducing unemployment on lower-income households.”

This would be surprising for many given the caricature of QE as simply amplifying inequality through asset price inflation. The fact that the empirical evidence finds that the most significant consequence is to reduce unemployment is especially significant in the current climate because the RBA has placed renewed emphasis on precisely this mission, which it says will meet its mandated objective of maximising the “economic prosperity and welfare of the Australian people”...

In its response to Wilson, the RBA further explained that these measures are not new: “The RBA already purchases government securities for liquidity management purposes… central banks implemented monetary policy a few decades ago largely by purchasing and selling government bonds.”

Long lost in this debate is the fact that the RBA has in the past actively intervened in foreign exchange markets to secure an Aussie dollar rate that is compatible with its policy goals, which is in principle a much more radical step than attempting to directly adjust domestic interest rates through buying and selling bonds.



Comments

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Jonathan Rochford

Well written Chris, we are in agreement that making sure banks never need a taxpayer bailout is more important than nebulous cultural aims and that a non-zero CCB is well overdue.

Harry

Sheer madness if more QE the asylum doors have been open for the past years and the likes of Draghi et al influencing the RBA is lunacy.