UpdatedReserve Bank of Australia governor Philip Lowe did a sublime job this week of radically recalibrating flawed market perceptions of the central bank’s mo
This means that Martin Place’s main focus is on buying Commonwealth and state government bonds to exert downward pressure on the escalating trajectory of long-term interest rates, which relieves the ensuing upward pressure on our exchange rate.
In the absence of the RBA’s valiant interventions, the Aussie dollar would be trading well north of US80¢, smashing exporters and import-competing businesses.
The message the market has failed to understand is that the RBA’s QE program is here to stay.
And with other global central banks increasing, rather than decreasing, their own bond purchases (as the ECB did on Thursday night), the RBA is likely to do more, not less, QE to ensure our economy is not disadvantaged vis-à-vis the rest of the world
netary policy posture while quietly, yet brutally, steamrolling short sellers that were questioning his commitment to unconventional stimulus.
.
All of this brings me toLowe’s blockbuster speech this week.
Traders and economists had convinced themselves that they could force the RBA to discard its three-year “yield curve control” policy, whereby it targets keeping three-year government bond yields at 0.1 per cent because of its struggles to defend the policy in recent times.
In particular, some in the market were aggressively betting against three-year Aussie yields remaining at 0.1 per cent by short-selling the relevant bonds and lifting yields above the RBA’s official target.
These traders were encouraged by chatter that the RBA was a reluctant QE participant, which was ostensibly reinforced by an awkward and unnecessarily academicdebate between Labor MP Andrew Leigh and the RBAon whether it could do more.
This left the impression that the RBA was sceptical about the benefits of additional QE despite its restraint on the exchange rate, incentivising traders to take Lowe on.
The brewing battle resembled a central bank trying to defend a currency peg. Every day trading desks were advising clients that there were mounting questions regarding the RBA’s credibility.
As long-term rates started to soar around the world in February, some offshore investors felt the RBA’s battle with markets was becoming a test case for all central banks.
Blow to short sellers
On Tuesday, the RBA delivered a savage knockout blow to the short sellers by two brutal means.
First, it stopped the Commonwealth treasury lending out three-year government bonds, which partially denied short sellers access to these assets to dump on market.
This meant the main lender of three-year bonds was the RBA itself, as its single largest owner (via QE). The second hammer was the RBA massively increasing the cost of borrowing these bonds, making it prohibitively expensive to short-sell them.
In just one day, Martin Place brought short sellers to their knees, and three-year government bond yields rapidly converged back to the 0.1 per cent target.
This was followed on Wednesday by Lowe’s speech, which was, as the governor remarked afterwards, designed to deliver some “clear messages” to investors.
The first was that contrary to widely held expectations, “the bank remains committed to the three-year yield target”.
In case you missed that message, Lowe repeated it: “We are not considering removing the target or changing the target from 10 basis points.” The only question was whether “to keep the April 2024 bond as the target bond, or to move to the next bond – that is the November 2024 bond – later this year”.
One bank commented that there was substantial interest in buying Aussie government bonds after “Lowe reiterated the RBA’s commitment to its three-year bond yield target, which we see as a response to markets challenging the credibility of the policy”.
Lowe’s second message was that (silly) expectations for “possible increases in the cash rate as early as late next year and then again in 2023” were plainly wrong.
Or, in his blunt words: “This is not an expectation that we share.” And by “we” he means the people that set interest rates!
A third message was that the RBA is comfortable with the idea of increasing QE whenever it needs to, as it did a couple of weeks ago when it bought $4 billion of bonds on a single day.
“We remain prepared to alter the timing of purchases under the current programs in response to market conditions,” Lowe affirmed. “We did this last week when liquidity conditions deteriorated...and will do so again if necessary.”
The fourth message was that markets should be pricing in a high likelihood of QE3 after the second $100 billion bond-buying program ends.
“Later in the year, the board will also consider the case for further extending the bond purchase program,” Lowe stressed. “We are prepared to undertake further bond purchases if that is required to reach our goals.“
The final, and arguably most significant message, was that the RBA has materially lowered its estimate of its “full employment” target down to a jobless rate in the low 4 per cent range.
Only a few years ago this was figured to be 5 per cent.
When asked byThe Australian Financial Revieweconomics editor John Kehoe whether full employment could be consistent with a jobless rate of just three-point-something per cent (as has been the case in the US), Lowe responded that this was “entirely possible”.
“I certainly hope, and it’s not inconceivable, that we could sustain an unemployment rate in Australia starting with a three,” he said.
This column foreshadowed that a three-point-something per cent full employment estimatewas plausible just one week ago.
Contrary to some claims, buying five- to 10-year Aussie government bonds has virtually no impact on home loan rates, which are determined by shorter-term, risk-free rates.
Lowe further explained that if a problem emerges with excessive housing ebullience, this would be dealt with via the banking regulator’s potent macro-prudential constraints on lending rather than through interest rate increases.
Critics of QE seem not to understand that there is no moral, ethical or philosophical difference between the RBA dropping its overnight cash rate to 0.1 per cent, and a QE policy that tries to keep the market’s best guess of what the cash rate will be over the next 10 years (as represented by government bond yields) as low as possible.
(20min delay)