Will lower interest rates fix the economy?
September delivered a wobble in risk markets combined with growing expectations of further RBA policy support delivering positive returns for fixed income investors. Risk market momentum turned negative for the first time since the violent sell-off in March, seeing key reversals in many market darlings of the last six months. Bond markets maintained solid negative correlations to equities, but the addition of further policy support from the RBA into Q4 further supported fixed income, whilst also being an additional drag on the AUD currency.
The focus of the RBA seems to have shifted to additional support via small interest rate cuts, and possible additional bond buying in longer maturities to stimulate the economy still beset by ongoing Covid-19 lockdowns in Victoria. This also seems targeted at lowering the currency to foster growth once the lockdowns end and the disaster relief funding of generous job keeper programs starts to wind down.
Against this backdrop, here I argue that the RBA remains a highly reactive Central Bank, with a very poor record around recent communications of medium-term monetary policy. Not long ago it was telling markets the neutral rate of interest was around 3.00% in the Australian economy – in a world of essentially zero interest rates, this looks like commentary from a parallel universe.
"The RBA kept rates at 1.50% for three years (mid-2016 to mid-2019) telling markets they didn’t envisage going any lower, but alas here we are at a 0.25% cash rate which is likely headed lower still, come the November meeting. Covid-19 is clearly the reasoning for such moves, but we believe Covid-19 is just a rapid accelerator of prevailing slow burning secular themes."
Hi, I'm Charlie Jamieson, Chief Investment Officer at Jamieson Coote Bonds, and this is a review of markets for September 2020. Over the course of the month, major focus has shifted back to the Reserve Bank of Australia, and some thinking in the markets that they could be on the policy warpath again in further cutting interest rates. It's very important to remember with the RBA that they are a tremendously reactive Central Bank, and they have misled markets with their own commentaries a number of times recently. And again, getting to this 25-basis point level, which they considered to be another new floor, it now looks like we'll be going lower again. Whether that's in October or November — we think November — but there will be further rate cuts, and that's very targeted to try and get the currency lower, in our opinion.
Further, on that reaction from the RBA, it wasn't long ago that they were telling us the neutral rate of interest in the economy was 3%. I think that's in a parallel universe to the developed world these days. Those rates just look far too high as we look around the globe. They kept rates at 1.5% for nearly three years from the middle of 2016 to 2019, telling us again that they didn't envisage going any lower. And yet here we are 25 basis points, some 125 basis points lower. Clearly, COVID is the reason, but COVID, in our opinion, is really just the accelerator of slower moving secular themes and this draw to very low rates around the world.
The RBA also told us that they didn't want to do quantitative easing. Quantitative easing is fully operational as we speak right now. And they are telling us that they'll look at negative interest rates, but they don't foresee using them. We don't want that to occur. Clearly, negative rates, we think, is a pretty ordinary policy. But nevertheless, with the Bank of England and the Reserve Bank of New Zealand also studying and making commentary about negative rates, it looks like policy makers are willing to throw everything at the problem of not being able to generate material growth in economies, and they'll try very unconventional policies following on from the actions of the likes of the Bank of Japan and the ECB.
So, I wouldn't trust the RBA in their commentary at all around the potential for a negative rate. In September, we had a stumble in risk markets, which broke the momentum that's been so powerful off the lows in March and April. And we're seeing a lot of things roll over. Clearly that the tech sector being fairly weak after a spectacular run. The US Dollar also found its feet and the Aussie pulled back quite substantially. And that has maintained that negative correlation relationship that we speak of all the time between fixed income and risk assets. But with the RBA starting to make some mention that they might be pulling the policy lever, and that stumble in risk markets, unsurprisingly Bonds had a very powerful performance over the September period. All of our solutions generated good solid returns and our global hedged had quite spectacular returns as a result of that currency depreciation.
Again, in the month of September, we had record amounts of bond issuance with the Australian government having an order book of $86 billion for its new 2026 maturity bond. They only ended up printing $25 billion worth of new securities, leaving material demand unsatisfied. That order book did get a little smaller when they tightened the pricing, but still it was north of $60 billion. This is just a staggering amount of demand for Australian bonds that remain very cheap in the context of global bond markets and have a very steep term structure. We'll talk more about the steepness of that term structure in following episodes, because we do believe it's very important.
We've got to the stage now where Jobkeeper is starting to wind down and this disaster relief stimulus that we've been so happy to receive it as an economy is starting to wind back. So, we do continue to foresee some problems ahead. We know that we are getting towards this northern winter period in Europe and the US, and already COVID case counts are going through the roof. Thankfully testing is much better and many of those presenting are much younger. So, at this stage we're not seeing universal lockdowns, but there have been some lockdowns and it does look like that could certainly continue.
It's very interesting to note that Trump's approval ratings have followed case counts and virus progression very closely, which also has had a very big impact on the US Dollar and risk markets as well. So, having just watched the first presidential debate, which was an absolute joke, I think there's a lot of confusion as to what will actually occur on the 3rd of November. We absolutely believe that we're off to the Supreme court, regardless of the result, and Trump will do everything in his power to frustrate that democratic process, and try and desperately retain power. So, there's probably plenty of twists and turns to come. We're going to be cautious with the way that we manage our own portfolios into that, given that there's so many potential outcomes, which could be very binary and happen very quickly.
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Charles is a co-founder of Jamieson Coote Bonds (JCB) and oversees portfolio management of the Australian and Global High Grade Bond and Dynamic Alpha investment strategies. Prior to JCB, Charles forged a career as a seasoned bond investor from...