Resilience and elasticity in the face of extreme adversity

Christopher Joye

Coolabah Capital

My heart goes out to the many millions of individuals, families, and businesses staring down the barrel of extreme, lockdown-induced adversity across the country right now. Every day, folks are losing their jobs, incomes, and, sadly, their way of life. Speaking to businesses, many say they are being permanently scarred by these unexpected events, and will not bounce-back with the same enthusiasm as they did in 2020 when they emerged from the original lockdowns, which they thought would be their last.

The complete shuttering of most economic activity in New South Wales, Victoria, and South Australia is not a recession, but rather a depression. The only other scenario that could conceivably induce such total paralysis would be outright war.

For those of us who are cosseted and not in the firing line, it is impossible to empathise, or imagine what those who are affected are enduring right now. But we can certainly try. 

And we can apply maximum pressure on public decision-makers to lift their heads out of the sand and do everything they possibly can to support affected Australians during this extraordinary, once-in-a-century shock propagated by the pandemic.

Unfortunately, the much more transmissible "delta" variant of the virus is different. And with our very low vaccination rates, countries like Australia, New Zealand, South Korea and Japan, who previously outperformed in 2020, are now more vulnerable than peers such as Canada, the UK, and Israel, who have given first vaccine doses to roughly 90 per cent of their adults. (We are sitting at about one-third of this level.) 

While the Prime Minister has sought to comfort us that there will be no double-dip recession, forecasting that we will quickly bounce-back from this depression, the risk is it continues for much longer than his hopeful confidence implies. 

Given how incredibly contagious delta is, as demonstrated by its spread around the world (reportedly infecting an amazing two-thirds of all Indians), coupled with the evidence that Australia's quarantine processes consistently leak, rolling lock-downs across the country must now be our highest-probability, and most prudent, central case until Australia finally gets to herd immunity some time in early 2022.

Close readers will recall our modelling that shows we should be able to vaccinate over 90% of adults by early 2022 at the latest, with a chance of doing so by end 2021 if we can speed-up the process. But the transmissibility of delta amongst children implies Australia should consider emulating the US roll-out of Pfizer to those aged 12 and older before assuming we have obtained herd immunity. Only then can we confidently open our borders and learn to live with the circulation of the virus throughout our community, which seems to be an early to mid 2022 prospect.

It is very clear that Sydney is likely to be in some form of multi-month lock-down until well into September. And then when we open back-up, there is every possibility that Australia's cities are forced into future lockdowns as a result of quarantine leaks. This is a new game-changer for the economy, which had been roaring ahead prior to the emergence of delta. 

You can certainly throw all that positive jobs data out of the window: it will shortly be supplanted by a dramatic increase in underemployment. And the most worrying risk is that we encounter even more potent, and potentially vaccine-resistant, derivations of COVID-19 in the months and years ahead.

One of my mentors, a former international athlete, talks a lot about trying to maintain "form" in the face of extreme duress. Anyone who is genuinely committed to a cause gets emotionally invested. Yet when the circumstances conspire against you, this emotion can become toxic, and undermine your form, or your ability to make the best possible real-time decisions under conditions of both unusual uncertainty and complexity. While it is hard to emotionally disengage when bullets are raining down upon you, that is exactly what you must try to do right now.

The goal is to lift yourself above the day-to-day challenge of trying to survive, and gaze with strength, clarity and purpose out over that brighter horizon where calmer waters lie. As tough as the days ahead might be, you can surmount these obstacles. You can learn to adapt, grow, and eventually prevail into a stronger, more resilient, and elastic version of yourself. Know that there is emphatically a light at the end of this very dark tunnel, albeit that is probably some six to nine months away...

For politicians and policymakers, including the Federal and State Treasuries, and the Reserve Bank of Australia, the worst thing they can do right now is stick their heads in the sand and pretend the problems will go away. The millions of Australians who are seeing their incomes slashed and jobs destroyed do not want inaction, empty homilies, or weasel words. 

The most absurd suggestion I've read in recent days is that if the authorities supply Australians with more economic stimulus it will actually undermine confidence, signal panic, and/or hurt the "credibility" of the institution in question. This irrationality beggars belief.

The most credible and appropriate thing any policymaker can do at present is to utilise all the tools at their disposal to immediately supply as much stimulus as they can, and to assume, for the sake of prudence, worst-case, not best-case, outcomes, in their efforts to bridge our way towards herd immunity. 

If we get a best-case scenario, and delta magically disappears, the recovery will be even more rapid as a result of the extra stimulus. In the much more likely contingency that this proves to be a long-running battle, the additional support will be precisely what is required.

One concern is that during February and the first half of March 2020, our policymakers were temporarily sluggish to react to the overwhelming data signalling that the pandemic would precipitate a cataclysmic crisis. The chairman of the US Federal Reserve famously ruled out using quantitative easing (QE), or bond purchases to reduce long-term interest rates, when he cut his cash rate in early March, only to be forced to reverse this decision weeks later. 

Once they were compelled into action, the RBA and Treasury did a magnificent job, and have been crucial providers of that "economic bridge" between the advent of the pandemic and that future state of nature when herd immunity arrives. But an objective assessment would find that, with the benefit of hindsight, decision-making could have been improved. In late March 2020 the RBA was brilliant at cauterising market illiquidity, slashing borrowing rates to all-time lows, supplying lenders with $200 billion of cheap money, and assuring businesses and households that they could rely on low rates for years to come. 

Yet in contrast to other central banks, the RBA was surprisingly six months late to commence its own highly successful government bond purchase, or QE, program, which has since kept the Aussie dollar much lower than it would otherwise be, furnishing critical support to exporters and import-competing businesses, and significantly lowering the interest repayment burden taxpayers bear through reducing borrowing rates on government bonds.  

In July the RBA created a new, highly "flexible" (as opposed to fixed) version of this bond purchase program, which Governor Phil Lowe has repeatedly explained allows the RBA to quickly increase or decrease its bond purchases depending on the circumstances. The RBA says that at its last board meeting, members discussed credible arguments in favour of maintaining the current run-rate of purchases at $5 billion per week, or trimming them slightly to $4 billion per week on the basis of some hopeful forecasts of the future.

Given the current economic complexity, and the nigh-on-impossible task of accurately predicting how the pandemic will unfold, the RBA says it is basing important policy decisions on actual events, and hard data, rather than rubbery guesses about what might transpire. In July it did, nonetheless, experiment with rolling the policy dice based on forecasts, even though it was in the midst of national lockdowns. It took only a matter of days for this hope to be superseded by the spectre of a potentially protracted depression.

The July decisions are now in the past, and no longer relevant. If the RBA held its board meeting today, there is zero chance it would have tapered. It equally knows that there is no value in pretending that the July decisions are somehow still germane by sticking its head in the sand. The most disingenuous claims are that the RBA can do nothing to help, or that the community would actually benefit from inaction because any immediate and timely response from the RBA would sap confidence. You cannot make this stupidity up. 

What the community obviously needs from its central bank is rapid recognition that the facts have changed and confidence that it will act with haste to supply as much support as it can. And because of Governor Lowe's prescience in establishing his new "flexible" QE program, he has compelling options at his disposal. 

As Westpac's Bill Evans has observed, there is nothing other than intransigence stopping the RBA from immediately lifting its bond purchases to say $6 billion per week for a period of time, which could be reviewed at future board meetings. This would signal to the community that more help is on its way, bolstering confidence that we will get through these difficult days, and put further downward pressure on the Aussie dollar and public sector borrowing costs.

Some argue that the RBA might risk buying too many Commonwealth government bonds, or owning too much of the "stock" of outstanding securities. While there are prospective limits here, the RBA is currently underweighting its purchases of State government bonds. Whereas 80 per cent of its QE is directed at the Commonwealth, only 20 per cent focusses on the States. Yet the States represent 30 per cent of the stock of government bonds and provide about 40 per cent of the current fiscal stimulus. 

Since the start of 2021, many economists have advocated recalibrating the RBA's QE operations to provide extra support to the States, which pay much higher interest rates than the Commonwealth, in line with their stock weights. Using Bill Evans' model, the RBA could simply boost the State government bond purchases by another $1 billion per week (ie, bringing the total to $2 billion per week), which would give the States one-third of the benefit of QE without reducing the stimulus directed towards the Commonwealth.

There are recent precedents for this: one of the RBA's key peers, the European Central Bank, increased the pace of its bond purchases earlier in the year when it became more worried about its outlook.

As fiscal policy has immediately adjusted to the current crisis, monetary policy should do likewise. The only options that are not on the table are inaction and delay. 

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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 40 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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