Quantitative Tightening

Christopher Joye

Coolabah Capital

Some "inside-baseball" monetary policy machinations were revealed by the RBA yesterday, which banks and other expert RBA watchers summarise as the central bank emulating the efforts of overseas peers by retaining a larger-than-expected post-pandemic balance-sheet size to maximise its policy optionality to respond to future shocks. 

As a result of bond maturities and banks repaying the $188 billion Term Funding Facility (TFF) in 2023 and 2024, the RBA has one of the sharpest balance-sheet contractions globally, which accentuates its monetary policy tightening (ie, this is equivalent to additional cash rate hikes). The balance-sheet reduction is so sharp that some local banks have argued the RBA should slow down its speed by embracing a more gradual TFF repayment profile. 

Banks are, however, very well positioned to repay the TFF ahead of time should they wish to, and have been raising large volumes of wholesale debt locally and globally with zero difficulties. 

The Aussie major banks' AA-rated senior unsecured and AAA-rated covered bonds remain in exceptionally high demand globally, as highlighted by CBA issuing US$1.75 billion of covered bonds during the week at a cost of capital inside its Aussie dollar funding levels. 

The RBA's Chris Kent, who is an excellent economist and unlucky not to get the Deputy Governor gig, will give a speech shortly on how the RBA sees its quantitative tightening (QT) program unfolding.

In the board minutes yesterday, the RBA signalled it was ruminating on its optimal balance-sheet size (presumably in the context of Governor Phil Lowe's recent remarks that there may come a time when it has to draw on QE again in concert with cash rate changes):  

The Board did not currently plan for the Bank to sell the government bonds it had purchased during the pandemic and it intended to allow the portfolio to run down in a predictable way as bonds mature. While contributing to the withdrawal of monetary stimulus, this would also recognise that the cash rate remains the primary tool for achieving the desired stance of monetary policy...Members noted that in some years' time, after the Bank's balance sheet had reduced further, the Board would need to consider the broader issue of the longer-term optimal size and composition of the balance sheet, including the size of Exchange Settlement balances. In this context, it might consider the use of longer-term bond holdings, although this would be driven by the appropriate operating framework in light of evolving conditions and would not have implications for, or have a bearing on, the stance of monetary policy.

In response, CBA's rates strategist Marty Whetton remarked:

The RBA also discussed the balance sheet and the idea that as TFF and bond holdings run down over the coming years, the board would “consider the optimal size and composition” of their balance sheet. This ostensibly washes up as the RBA maintaining a balance sheet larger than what it was pre‑pandemic and the ability to use it as it needs.

Nomura's Andrew Ticehurst expanded on this:

The minutes also reveal further detail around the RBA’s plans for balance sheet reduction. The RBA confirmed it has no plans for outright bond sales, but went further today, suggesting this might remain the case for some years. It noted that the balance sheet will start to diminish “quite quickly” in 2023, as a significant share of the Term Funding Facility rolls off by September of that year, with the remainder rolling off by June 2024. It did reserve the right to review the size and composition of its balance sheet, but “in some years’ time”, and noted that “the cash rate remains the primary tool for achieving the desired stance of monetary policy”.

In the media, Sophia Rodrigues from Centralbankintel offered the most exhaustive exposition:

The Reserve Bank of Australia’s communication in the minutes of the board meeting suggests it may consider buying longer-term bonds after some years to ensure the balance sheet is higher than its pre-pandemic levels.
This effectively means even after Quantitative Tightening is implemented and the balance sheet shrinks, the aim is to ensure total Exchange Settlement balances will be higher than around A$30 billion that prevailed before March 2020, and surplus ES balances will be well over A$3 billion.
The RBA’s plan is no different from other major central banks that have already communicated their plans to operate monetary policy under an ample reserves regime.
The Federal Reserve, for example, said, “Over time, the Committee intends to maintain securities holdings in amounts needed to implement monetary policy efficiently and effectively in its ample reserves regime.”
This means the Fed will allow reserve balances to decline to a point where it is judged to be at an ample level, and after that, it would “manage securities holdings” as needed to maintain ample reserves over time.
The Bank of Canada said it will need to start acquiring assets again at some point for “normal balance sheet management purposes.”
The Bank of England noted that a reduction in the stock of purchased assets could mean that reserves have fallen to the level demanded by participants in the Sterling Monetary Framework at the prevailing level of Bank Rate.
That level of reserves is highly uncertain, and will vary in response to financial and economic conditions, it said.
“While it is likely to be some way below the current level of reserves, it is also likely to be materially higher at any given level of Bank Rate than it was before the financial crisis, given a range of changes over that period, such as changes to funding markets and liquidity regulation.”
The Reserve Bank of New Zealand said it will monitor money market conditions as the settlement cash level declines and will review its facilities and operations to ensure short-term interest rates trade at or near the official cash rate at all levels of settlement cash. 
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Christopher Joye
Portfolio Manager & Chief Investment Officer
Coolabah Capital

Chris co-founded Coolabah in 2011, which today runs over $8 billion with a team of 26 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...

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