The quantitative tease stakes: Will the RBA run with the Fed favourite?

Ever thought a macro article would be compared to a horse race? Well, I have and in this case, it's central banks who are mingling behind the starting stalls for the “Quantitative Tease Stakes,” an event that is expected to be run over the next two years. Who do we think will cross the 2.5% terminal rate finishing line first – and more importantly, who has no interest in running the race?  
John Abernethy

Clime Asset Management

For over a decade, Central Banks have mingled behind the starting stalls for the “Quantitative Tease Stakes,” an event that is expected to be run over the next two years. It's a handicap with each Central Bank starting with different cash rates (really a handicap) and which they have each given themselves. The winner will be the first Central Bank to reach 2.5% cash rate and that is why the starting handicap is so important. It also suggests that some Central Banks have no intention of trying to win this event. So to speak they will be running dead!

The US Federal Reserve (the Fed) has already re-handicapped itself with a 0.25% penalty. It has a plethora of trainers keen to jump it out quickly and some have indicated that they want the race over by Christmas. 
The US trainers, unlike their European and Japanese peers, see no issue with their lead bags overflowing with government debt. That could be a serious error of judgement.

Punters should recall that the Fed did have false starts in 2017 and 2018. It ran hard to 2.4% before it realised that no other Central Bank was interested in contesting that race. The Fed endured the boos from an irate capital market on returning to the enclosure for a hose down. The good news is that for this race, the Fed has a new jockey and it currently sits at 0.35%.

Others in the birdcage are a mixed field. The Bank of Japan (BoJ) has been sitting docilely in the stalls for the last two decades and so there must be a risk that it has fallen asleep. At “negative” 0.10%, it appears happy to give most of the other runners a start. The BoJ understands a long race and rest assured it will run along steadily with QE holding it together. Arguably the BoJ is in the wrong race - a long shot indeed.

The European Central Bank (ECB) continues to back out of the stalls as it struggles to find a jockey who can justify the “negative” 0.5% starting position. If the ECB fails to jump, and that is a sure thing, the trainer has promised a new riding style to ensure the southern European back legs keep up with the northern European front legs. The stewards will be watching carefully for any riding indiscretions although I note that they have missed the last 10 years of rate rigging.

The Canadian and United Kingdom Central Banks have already moved forward and they will attempt to make pace with the Fed if that bank follows through on its pre-post stated intention to be ridden aggressively up the interest rate scale. Just how long they can endure the hectic pace promised by the Fed, and on a soggy track, is an issue that punters will have to consider. The UK does have a stout long-distance pedigree, while Canada is more a sprinter type with cross-breeding.

Russia has been a late scratching after it decided to run its own race and has copped a 17% cash rate penalty whilst it sits on the sidelines. Punters were left scratching their heads.

Russia has been replaced by the first emergency, the Reserve Bank of New Zealand. This bank was already jumping in the enclosure and has taken full advantage of its obscurity by loading up with a 1.5% cash rate. Whilst it will be ahead of the Fed on jumping, it is not likely to stay the distance and will run out of puff well before the two years pass. It looks suspiciously like a pacemaker for the Fed that has no intention of being in the finish.

By the way, the Chinese Central bank has not nominated for this event, its vet ordering it to stay in the stall until further notice. Betting exchanges in the Solomon Islands seemed to have been tipped off about this before Western markets.

In Australia, it has been confirmed that our starting rate is positive 0.10%, even though the Opposition Leader claimed it was an unknown factor. No wonder the betting odds have shifted so much.

There is also some doubt regarding the RBA’s jockey. The current hoop wishes to retire in September 2023, just as the race looks like entering the final stage when it turns from a flat race to a hurdle. The RBA stable has already endured the loss of an assistant trainer who jumped stable and moved over to the private sector.

So, there we have the runners, and punters must be pondering whether the 100 to 1 being offered for the BoJ and the 50 to 1 for the ECB are odds worth considering. My view is a resounding “No”. Both will miss the start hopelessly and the stewards should already be questioning them.

Clearly, the Fed must retain favouritism but punters should consider the consequences of it running hard while being burdened with government debt lead bags. With 110% government debt to GDP, it may need to revert to QE as the post nears and before bond markets tear up betting tickets.

It is my view that the race is likely to break into two distinct groups. The question is whether the RBA goes forward with the US or eases back with the ECB and BoJ. Pre-race, the RBA has declared its intention to move forward but it will also clearly miss the start while the election fashion parade in the Members enclosure is held.

Overall, it's a confusing race that will start (for some runners) in early June.

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John Abernethy
Clime Asset Management

John has 35 years experience in funds management and corporate advisory services. Prior to establishing Clime, John’s roles included ten years at NRMA Investments as the head of equities. Clime is a management and advisory business for mainly SMSFs.

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