Macro

Today I argue that since we blindsided participants by first putting the likelihood of the Reserve Bank of Australia launching quantitative easing (QE) back in May, there has been no end of gas-bagging initially dismissing the possibility, then reluctantly acknowledging it and now thinking about how to trade it. In its August board minutes, the RBA has squarely put the live prospect of QE on the table, and it is now probably only a question of when and in what form if the RBA is serious about getting inflation back to its target 2-3% band and reducing the jobless rate to between 4% and 4.5%. The RBA has clearly signalled that its preference will be for a comprehensive package of measures rather than relying on one specific tool (eg, only buying government bonds), which will likely include further reducing short-term bank credit risk premia as proxied by the bank bill swap rate, extending out its current direct bank financing operations to terms of 12 to 24 months, and purchasing government bonds and possibly other assets that are already eligible for its financing or repurchase facilities, such as bank covered bonds, senior bank paper, and AAA rated RMBS and ABS. There is little doubt that if the RBA does this it will indeed radically reduce funding costs and facilitate lower savings and loan rates. I also go on to present our new quant analysis on the rise of Zombie companies listed on the ASX, which is excerpted below (click on that link to read the column or AFR subs can click here):

While some think QE is a radical next step, it is simply about allowing the RBA to influence a wider range of interest rates that better reflect the cost of borrowing across the economy rather than just limiting itself to its (theoretical) target cash rate.

History suggests that if the RBA does start QE because of the cash rate’s effective lower bound, there is no point doing so in a half-hearted fashion. It is going to be much more effective erring on the side of a more assertive program, which can be subsequently moderated if core inflation returns to the RBA’s target band and the jobless rate drops down to its full employment level around 4.5 per cent.

There is also merit in the RBA warming the market up for QE to maximise the efficacy of any future cash rate cuts before it reaches the effective lower bound. The RBA can capture substantial “announcement effect” benefits simply by stating it is considering a range of QE alternatives. In a way, its August board minutes lay some the foundations for this evolving narrative.

One downside of cheap money is the emergence of so-called “Zombie companies”. We quantitatively monitor the presence of these zombies in the Australian economy using a definition adopted by the Bank for International Settlements. A company is classified as a Zombie if it is listed, has been in existence for more than 10 years, and if its interest coverage ratio (ICR) has been less than one for at least three consecutive years.

My quant team finds that there has been a 57 per cent increase in the number of ASX zombies in the last eight years alone from 10.8 per cent of the market to over 17 per cent in 2018. This is something that all savvy investors should be focussed on avoiding—that is, businesses that are unsustainable in anything other than a zero interest rate world.

Read the full column here.




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Patrick Fresne

I'm currently running the ruler over some of these 'zombie companies', especially those operating in cyclical industries. These companies tend to have depressed share prices, yet the current record-low interest rate environment provides a fantastic opportunity for indebted companies to escape from the downward spiral, assuming their management is at least competent. Apart from that, the low interest rates increases the chance of a debt-fuelled takeover of such stocks by larger peers, especially if they are sitting on some interesting or attractive assets.