The coming of Aussie QE

Christopher Joye

Coolabah Capital

This week I argue that while RBA governor Phil Lowe passed with flying colours the controversial intelligence test we pitched him last week (by not cutting the cash rate in May), he is nonetheless likely to cut over the next few months. And although he is exhausting his conventional monetary policy tools, he is probably comforted by the fact that there are other tricks up his sleeve. In particular, as the cash rate nears zero, Lowe can embark on Aussie quantitative easing in the form of buying both long-dated government bonds and portfolios of asset-backed securities (ABS) and residential mortgage-backed securities (RMBS), which would help lower the cost of home loans and SME loans. All of this would have profound consequences for portfolios: the great Aussie housing correction will come to an end; the bid for spread assets will intensify dramatically; and we will turn our minds to revisiting RMBS as an asset-class of opportunity (click on that link or AFR subs click here). Excerpt enclosed:

Another reason Lowe will cut if the jobless rate does not materially drop (which it could do), is that he is probably not that exercised about exhausting his policy ammunition given the optionality of initiating an Australian version of quantitative easing (QE)...

As the cash rate gets near zero, the RBA will want to extend the idea I successfully pitched to the Rudd Government with Professor Joshua Gans in 2008, which involved the government buying $15 billion of residential mortgage-backed securities (RMBS).

The RBA already accepts AAA rated RMBS as collateral when lending to counterparties through its repurchase, or repo, arrangements, which was a change introduced during the crisis that substantially improved the liquidity of, and thus the demand for, these securities.

Taking one step further by engaging in an outright RMBS buying program, as other central banks did during the crisis, would be particularly potent for Aussie home loan rates by reducing the cost of capital for both banks and non-banks that source money via selling RMBS bonds backed by home loans.

If the RBA wanted to concurrently ease the cost of small business borrowing, they could extend this to buying portfolios of small and medium enterprise (SME) loans alongside Scott Morrison’s new Australian Business Securitisation fund.

I proposed this solution to the prime minister, which involves the government investing $2 billion into asset-backed securities (ABS) full of SME loans to help attract global institutional capital to the sector, which will enhance the liquidity and reduce the cost of funding small businesses in Australia just as we have seen the booming RMBS market do for housing.

A 1.0 per cent RBA cash rate will translate into substantially higher demand for any relatively low risk assets paying decent spreads above it, including bank and insurer bonds, hybrids (Labor's franking policy appears dead), and ABS and RMBS.

So while we sold our RMBS holdings in February 2018, and it has been the worst performing fixed-income asset class in 2019, I am preparing to revisit this opportunity in around 1 or 2 years.

Before doing so, I would want to see what the Federal Court has to say about ASIC’s case against Westpac on responsible lending, which should favour the latter, and observe house prices recovering.

And I will avoid like the plague any home loans written between 2016 and 2019 that have suffered from falling house prices, deteriorating collateral, higher arrears, and potential breaches of responsible lending laws.

Given the choice, I will also always prefer bank-issued RMBS over non-bank bonds since the latter are not ordinarily regulated by APRA, which is the global gold standard when it comes to minimising credit risks.

Disclaimer: This information has been prepared by Smarter Money Investments Pty Ltd. 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. Past performance is not an indicator of nor assures any future returns or risks. Smarter Money Investments Pty Limited (ACN 153 555 867) is authorised representative #000414337 of Coolabah Capital Institutional Investments Pty Ltd, which holds Australian Financial Services Licence No. 482238 and authorised representative #414337 of ExchangeIQ Advisory Group Pty Limited that holds Australian Financial Services Licence No. 255016.

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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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