RBA sets up July to move to open-ended QE, likely exceeding $100 billion

Christopher Joye

Coolabah Capital

The RBA has provided clear signalling that in July it will move to a new form of open-ended quantitative easing (QE) at the current run-rate of $5 billion of bond purchases each week, which will be periodically reviewed. This will avoid the policy rigidity of static, five monthly QE programs at $100 billion a pop, and allow the RBA to smoothly glide towards a tapering into 2022, as we and most other forecasters expected. If the data is very positive, the RBA can taper in 2022. If it is negative, the RBA can maintain the current bond purchase pace. It will also mean that the extended $5 billion per week of purchases between mid-September and mid-December plus the eventual tapering into 2022 will involve the RBA likely acquiring more than $100 billion of additional bonds. At its July board meeting, we believe the RBA will de facto taper through not extending its 0.1%, 3-year yield curve target from April 2024 to the November 2024 bond, and via the expiry of its $200 billion term funding facility on 30 June.

The RBA likes to condition policy changes via media signals and has done so for decades, which allows for a smoother transmission mechanism. One of the problems with using media proxies is that the messages can get mangled in translation. We see this all the time. 

Another issue is that media commentators high on their RBA imprimatur can start mixing in their own lofty opinions alongside the RBA’s messages, which can then make the latter hard to decode. We have also seen that problem repeatedly from high-profile commentators over the years.

The best financial journalist in Australia is arguably John Kehoe, who is now economics editor at The Australian Financial Review. Kehoe is very smart, very precise, and lacks ego, which makes him the perfect conduit for Martin Place to channel complex messages. When he writes on behalf of the RBA, he delivers their signals, nothing more or less. This is crucial for clarity.

A case in point was the RBA’s latest board meeting on Tuesday. The first key question is what the RBA does with its 3-year yield curve target, and whether it rolls this over from the April 2024 government bond to the November 2024 bond.

A second question is what the RBA does with its successful quantitative easing program, which has kept the Aussie dollar trading with a 7-handle and Aussie 10-year interest rates from soaring above US rates.

A final question that had the entire market aflutter was the RBA removing a line from its statement that said: “the Board is prepared to undertake further bond purchases to assist with progress towards the goals of full employment and inflation”. This line came after the RBA’s now-standard comment that “at the July meeting the Board will also consider future bond purchases following the completion of the second $100 billion of purchases under the government bond purchase program in September”.

Irrelevant RBA language adjustment

The line the RBA removed first appeared in March in this form: “and the Bank is prepared to do more if that is necessary”. In April it evolved to: “Beyond this, the Bank is prepared to undertake further bond purchases if doing so would assist with progress towards the goals of full employment and inflation”.

And finally, in May it was truncated to: “The Board is prepared to undertake further bond purchases to assist with progress towards the goals of full employment and inflation”.

Yet since the RBA has clearly signalled more bond purchases are coming since its May meetingb when it first disclosed that it would decide their size in July, this line is no longer necessary. It had become redundant and was removed because QE3 is coming, albeit likely in a more flexible form.

Kehoe explicitly confirmed this, commenting in his column after the June board meeting that, “Yet markets may have over-interpreted the change in language, which was probably not intended to convey a particular direction”.

So we now know, via Kehoe, that the change in language was neither a hawkish nor dovish signal, but rather simply the removal of the redundant QE qualifier that is no longer necessary given the RBA is committed to doing more in July.

It might seem like a trivial clarification, but a lot of people wasted a lot of time thinking about that one change. That brings us to the two key monetary policy decisions in July.

Yield curve target likely not extended

On the question of whether to extend to 3-year yield target to the November 2024 bond, Kehoe explains that doing so “would imply the RBA believes the 0.1 per cent overnight cash rate won’t rise until after 2024 – an arguably dovish tilt from its current guidance that a rate rise is “unlikely to be until 2024 at the earliest’”.’

“For credibility reasons, the RBA would want to be fairly confident that the cash rate was not going to increase until after 2024,” Kehoe continues. “While that’s possible, if the labour market continues to improve, it’s perhaps not a scenario the RBA can stake its credibility on.”

So, barring a big deterioration in the labour market, it would appear that it is unlikely that the RBA will extend to the November contract, which has been Coolabah’s base case for a while (albeit not one we have had a strong view on).

Kehoe sums it up as: “Though finely balanced, extending the yield curve target seems a bit less likely.”

Open-ended, $5 billion a week, QE Clearly Signalled

On the so-called QE3, Kehoe first rules out any removal of the program, which would be a huge shock to financial markets. Specifically, he comments: “Quantitative easing will continue in some shape or form”.

Here another commentator, Karen Maley, claimed the market did not react to the RBA’s statement on Tuesday because it expects a taper. First, the market did react, with the Aussie dollar falling noticeably because market participants were hoping the RBA would be more hawkish. Overall, the statement was considered to be fairly dovish vis-à-vis expectations.

While the market is expecting soft tapering in the form of (1) the end of the RBA’s term funding facility and (2) the likelihood that the RBA will not extend its 3-year yield curve target to November 2024, this is not true in the case of QE.

All the big forecasters like ANZ, Westpac, Citi, Goldman Sachs, HSBC, TD and others expect the RBA to do a third round of QE that is $100 billion in size (RBC and UBS think it could be up to $100 billion). Only a minority of forecasters, like CBA, project a serious taper down to $50 billion in size.

We know that every taper ever attempted by a central bank in the past has had a market impact, and this time is likely to be no different. The Canadians have tapered twice - in October 2020 and April 2021 - and their currency has soared 10% above both the US dollar and the Australian dollar.

So Kehoe begins by telling us that “the easiest option will be to add another $100 billion at the existing pace”, which would be consistent with the consensus view.

His most interesting remark, however, is a new program, which he flagged after the RBA’s May meeting, which is to stick with the $5 billion a week of purchases (ie, the run-rate of the first two $100 billion programs), but “to introduce some flexibility” without stating exactly what that flexibility means.

Significantly, Kehoe adds, “the RBA has historically liked to have flexibility on monetary policy”.

Kehoe first canvassed this open-ended QE program at $5 billion per week following the RBA’s May meeting. Here he was more precise, stating: “A third more flexible option is to continue QE over an unspecified timeframe, and to review the bond-buying program periodically, such as each month or so, as the Bank of Canada has committed to”.

Finally, on a proper QE taper down to say $75 billion or $50 billion, Kehoe noted it is a final option, but cautioned this week that while the Canadian and New Zealand central banks have tapered, “Canada is already around its 2 per cent inflation target and New Zealand unemployment is a low 4.7 per cent”.

In contrast, Kehoe retorts that, “in Australia, the weakness in prices and wages is much more entrenched”, leaving him to conclude that, “hence, Lowe will want to do more, it’s just a matter of how much”.

We know that core inflation in Australia is running at 1.1% annually, miles below the mid-point of the RBA’s 2-3% range in contrast to central banks in the US and Canada, wages growth is very weak at 1.5% year-on-year, near an all-time low, and the jobless rate at 5.5% is still potentially years of stimulus away from the real natural rate of unemployment, which is potentially in the 3s.

So what can we take from all of this? In summary, Coolabah’s view is as follows.

First, the RBA will likely not extend the 3-year yield curve target from April to the November contract. Second, the RBA will likely commit to a new form of more flexible and open-ended QE at the current run-rate of $5 billion a week with a periodic review. Importantly, this could ultimately mean longer and more sizeable QE than a one-off, $100 billion program for just six months.

Total Open-Ended QE Should Comfortably Exceed $100 billion

If you think about the current QE2 program’s expiry in mid-September, it would make sense to review the new open-ended QE3 run-rate every few months, as Kehoe has suggested, with perhaps the December board meeting prior to the January break an optimal juncture to evaluate the size of the monthly purchases.

That would imply $75 billion of bond purchases between mid-September and December. If all the central banks have started tapering by then (Australia will emphatically not want to get ahead of the US Federal Reserve), the RBA might at that stage keep the $5 billion weekly run-rate or reduce it to say $4 billion or $3 billion in December with another review in three months.

Assume the jobless rate is at 5%, everyone is tapering, and the RBA reduces to $3 billion a week for another 3 months. That would be an extra $45 billion of bond purchases.

If the economic data continued hitting it out of the park, and there was no bad news, one could imagine an orderly tapering down to $1 billion a week for a further three months. That scenario would suggest the RBA has $125 billion to $130 billion of QE left to do, subject to the data playing out perfectly.

Obviously, if there are any setbacks, downside surprises, lockdowns etc, the RBA could simply maintain its weekly bond purchases at a given pace, which means its balance sheet would expand more than the circa $125 billion of extra purchases implied by the aforementioned optimistic scenario.

Here it is critical to remember that as a share of GDP, the RBA’s QE-driven balance-sheet growth has massively lagged its central bank peers overseas. At the same time, it has, as Kehoe highlighted, a structural problem generating core inflation in line with its 2% to 3% target, which surveys data suggests may be dragging down inflation expectations. 

Access Coolabah's intellectual edge

With the biggest team in investment-grade Australian fixed-income and over $6 billion in FUM, Coolabah Capital Investments publishes unique insights and research on markets and macroeconomics from around the world overlaid leveraging its 13 analysts and 5 portfolio managers. Click the ‘CONTACT’ button below to get in touch.

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 www.coolabahcapital.com. 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.