Uncertainty problem is getting worse Market minds AFR 14 October...

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    Uncertainty problem is getting worse

    Market minds

    AFR 14 October 2019
    Chris Dickman

    Spare a thought for the bond and currency traders of the world, who were caught between the duelling forces of risk-off, risk-on headlines as the trade talks picked up the pace on Thursday and Friday.

    Everyone knows investors hate uncertainty. This is what market uncertainty looks like, and it moves prices, as the dollar-yen foreign exchange pair showed by whipsawing around on the confusing sequence of information.

    As we know, businesses hate uncertainty too. But unlike investors, businesses cannot reverse their decisions easily.

    Once they have committed to buying inventory or building things or hiring people, businesses have to follow through.
    It may sound hard to believe, but governments are doing the opposite of providing more certainty.

    Readers won’t need to hear another call for fiscal policy to come to the rescue, as we all mostly agree we have an over-active monetary policy gland, but some government-led policy is either ineffective, or arguably, getting in the way.

    Even if governments don’t want to blow the budget (which is a reasonable policy stance), a lift in policy themes such as public-private partnership activity has the advantage of providing businesses with certainty with respect to construction and infrastructure. There’s not enough of this.

    Instead of holding the umbrella and protecting their economies from global uncertainty, governments have taken the umbrella away and turned on the garden hose.

    In many advanced economies, policy is not being conducted in a way that assists in providing an element of certainty to the decision-making process of local business.

    Germany, for example, running contractionary fiscal policy at a time when its export markets have collapsed following the trade war is appalling policy. It is saving for a rainy day (maintaining a 2 per cent of GDP budget surplus) but seems to be ignoring the thunderstorm that has descended upon it.

    Germany has benefited from the euro experience and Chinese consumer expansion, but it hasn’t escaped a collapse in industrial production. It doesn’t even appear to have a policy response to correct this. On the heels of Mercedes and VW, BMW last month announced cuts to its German workforce. This has made the European Central Bank do the policy heavy-lifting.

    Australia, too, is overly focused on the balanced budget and its prized AAA credit rating. Indeed, Reserve Bank governor Philip Lowe has spoken of other policies that may be needed.

    Businesses are craving a pick-up in confidence that would arrest the slide in investment. And it’s not just Germany – the rest of Europe continues to consolidate fiscally. Elsewhere, populist government actions – in the US, UK and southern Europe – have caused the business uncertainty.

    As I’ve written before, the path of European and Japanese rates is critical to Australia, because of the floor created in the global interest rate market by negative yields. But they are also a magnet, such as when investors sell their negative-yielding Japanese government bonds (JGBs) and German bunds to their central banks to buy higher-yielding Australian and US government bonds. In turn, this drags Australian and US yields lower.

    We have just shared another conclusion with our clients: that European and Japanese interest rates are at the ‘‘reversal rate’’. This is the rate where instead of boosting bank lending, interest rates are low enough to have a contractionary impact on the banking sector – and thus the economy.

    So, a higher bar now exists for deployment of further QE or deposit rate cuts. We agree that Australia is increasingly likely to turn to QE.

    Do we think that’s a good policy? No, but that doesn’t mean it won’t be deployed – especially while the fiscal response is absent. While that is the case, the grinding convergence of Australian bond yields towards the global floor remains a threat.

    Chris Dickman is a senior portfolio manager at Altius Asset Management.
 
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