Is the RBA taper vs non-taper decision a non-event for September?

Christopher Joye

Coolabah Capital

The RBA "taper vs non-taper" decision for its bond purchase, or quantitative easing (QE), program will be resolved in September with many banks (eg, UBS, DB, CBA, Westpac etc) calling for a taper deferral (or increase in Westpac's case). This would involve the RBA maintaining its current bond buying pace at $5bn/week through to the next quarterly review in November, or possibly February 2022. 

The truth is that the increasingly most probable "slow taper" vs "non-taper" outcomes in terms of the actual $ value of RBA bond buying (and hence the ultimate stock of bonds they hold) are not that materially different: they are all large, and well above the original consensus for QE3 (as the RBA has noted through media proxies). Importantly, the "slow taper" path is also bigger than the RBA's previous base-case.

If the RBA did defer the taper, keeping the current $5bn/week buying rate between September and the first quarterly review starting in November, and then stepped-down by $1bn/week each quarter thereafter (ie, what we will call a "5/4/3/2/1" quarterly schedule in $bn/week terms), it would end-up buying about $157bn of bonds for QE3 (a faster schedule of 5/4/3/2/0 is still worth $149bn). 

On the other hand, if the RBA went with the faster taper 4/3/2/1 schedule, which was clearly its base-case in July, it would buy $105bn (a harder taper 4/3/2/0 schedule was still worth $92bn). Note that this was broadly in line with consensus at the time, which the RBA highlighted in its minutes (ie, the consensus).

While we are agnostic on the actual outcomes, we currently believe the most likely path is the slow taper of 4/4/3/2/1 or 4/4/3/2/0 based on consistent media signalling (see more on this at the end). This would also see the RBA completing the program by mid-to-late next year, a little behind peer central banks in line with its desire to also hike rates after its peers. 

Both these slow taper schedules give $147bn and $139bn of RBA buying, which are actually similar to the taper-deferral purchase programs and well above the original consensus estimates for QE3 (recall CBA was at $50bn for QE3 and UBS was around $75bn with consensus $75bn to $100bn before July --- CCI has always been at $100bn plus). 

It would appear that a gradual 4/4/3/2/1 schedule is the most likely glide-path because the RBA is starting to stress via the media again that it wants to be the slowest central bank to tighten policy, especially following the downside surprise on wages, amplified by the recent shuttering of economic activity across more than half the metro population. 

The RBA might also start to focus on the fact that unlike other countries, Australia does not have any natural immunity; that is, say 10-20% of the population who have already had COVID-19 as is the case in countries like the US and UK. This means that effective vaccination rates for Australia will have to be higher than the rest of the world at perhaps 80%-90% of the total population. It also implies a more sluggish recovery from Delta in Q4 this year and Q1 next year. 

Our view is that the RBA taper has been primarily motivated by bond market capacity issues, which has been a common hypothesis in the market (Ricardian Ambivalence does a great job summarising the easily-resolvable-issues here  and the obvious solutions here). 

If the RBA wants to avail itself of some creativity, which would be frankly surprising, there are loads of options in terms of finessing the semis/govvies mix and extending the buying envelope to relax these capacity constraints, as Ricardian Ambivalence outlines.

But given the RBA's sub-optimal shift from nowcasting to forecasting, which has made decision-making much more mercurial, we have no real view on whether they do get creative. 

They could, for example, run with a 4/4/3/2/1 schedule and recalibrate the semis (up) and govvies (down) to say 30:70 (from 20:80 currently) to alleviate pressure on both semi spreads and swap spreads, especially given semi spreads over Commonwealth government bonds have recently increased by some 25-30 basis points back to 2019 levels (and to levels that are generally higher than those that prevailed over the 2014 to 2019 period, as the chart below shows). In fact, for the first time in history, benchmark NSW and Victorian government bond spreads over Commonwealth government bonds are actually as high, or higher than, the spreads on lower rated and much more illiquid 5-year major bank senior bonds. 

This is mainly because banks have been buying each other's bonds as a replacement for government bonds in their Committed Liquidity Facility (CLF) portfolios, which is a form of regulatory arbitrage that will likely be closed down over time by APRA and the RBA (see more on this here).

We have been closely watching key RBA media proxies, which are telling a similar story: Glynn (WSJ)/Maley (AFR)/Rodrigues (CentralBank Intel)/McCrann (News Ltd) are all directly or indirectly pointing toward the RBA offering the concession to the current recession of a 4/4/3/2/1 schedule, or $147bn of buying, which they note is more than the market had originally expected (the RBA has obviously been stressing this point regarding a bigger stock of bonds that had been priced). 

In making these decisions, the RBA might also be mindful of the recent upward pressure on swap spreads, which seems to be driven by QE's overweight to govvies that is no longer justified by either the relative stock weights, the flow of supply, or the fiscal stimulus.

Investment Disclaimer Past performance does not assure future returns. All investments carry risks, including that the value of investments may vary, future returns may differ from past returns, and that your capital is not guaranteed. This information has been prepared by Coolabah Capital Investments Pty Ltd (ACN 153 327 872). It is general information only and is not intended to provide you with financial advice. You should not rely on any information herein in making any investment decisions. To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information. The Product Disclosure Statement (PDS) for the funds should be considered before deciding whether to acquire or hold units in it. A PDS for these products can be obtained by visiting Neither Coolabah Capital Investments Pty Ltd, EQT Responsible Entity Services Ltd (ACN 101 103 011), Equity Trustees Ltd (ACN 004 031 298) nor their respective shareholders, directors and associated businesses assume any liability to investors in connection with any investment in the funds, or guarantees the performance of any obligations to investors, the performance of the funds or any particular rate of return. The repayment of capital is not guaranteed. Investments in the funds are not deposits or liabilities of any of the above-mentioned parties, nor of any Authorised Deposit-taking Institution. The funds are subject to investment risks, which could include delays in repayment and/or loss of income and capital invested. Past performance is not an indicator of nor assures any future returns or risks. Coolabah Capital Institutional Investments Pty Ltd holds Australian Financial Services Licence No. 482238 and is an authorised representative #001277030 of EQT Responsible Entity Services Ltd that holds Australian Financial Services Licence No. 223271. Equity Trustees Ltd that holds Australian Financial Services Licence No. 240975. Forward-Looking Disclaimer This presentation contains some forward-looking information. These statements are not guarantees of future performance and undue reliance should not be placed on them. Such forward-looking statements necessarily involve known and unknown risks and uncertainties, which may cause actual performance and financial results in future periods to differ materially from any projections of future performance or result expressed or implied by such forward-looking statements. Although forward-looking statements contained in this presentation are based upon what Coolabah Capital Investments Pty Ltd believes are reasonable assumptions, there can be no assurance that forward-looking statements will prove to be accurate, as actual results and future events could differ materially from those anticipated in such statements. Coolabah Capital Investments Pty Ltd undertakes no obligation to update forward-looking statements if circumstances or management’s estimates or opinions should change except as required by applicable securities laws. The reader is cautioned not to place undue reliance on forward-looking statements.

2 topics

Christopher Joye
Portfolio Manager & Chief Investment Officer
Coolabah Capital

Chris co-founded Coolabah in 2011, which today runs $7 billion with a team of 33 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...

I would like to

Only to be used for sending genuine email enquiries to the Contributor. Livewire Markets Pty Ltd reserves its right to take any legal or other appropriate action in relation to misuse of this service.

Personal Information Collection Statement
Your personal information will be passed to the Contributor and/or its authorised service provider to assist the Contributor to contact you about your investment enquiry. They are required not to use your information for any other purpose. Our privacy policy explains how we store personal information and how you may access, correct or complain about the handling of personal information.


Sign In or Join Free to comment