RBA board meeting – what we know and what to expect
Governor Lowe hinted in a mid-October speech that there was a readiness on the part of the RBA to ease further as the economy continues upon the reopening trajectory with restrictions being wound back gradually and state borders beginning to reopen. With further policy easing gaining “more traction” as the economy continues to reopen.
Further, the board has conspicuously addressed unemployment as a “national priority”, this language around the labour market signalling an openness to ease again. In addition, in recent weeks, since Governor Lowe’s speech various board members have done anything but downplay now firmly entrenched market expectations.
Inflation data released earlier this week, despite rebounding, still remains well below the RBA’s 2-3% target band. Although there is likely to be ongoing volatility in price trends as the pandemic disrupts both demand and supply across various components, the data does not detract from the RBA’s delivery of further easing next week.
The Governor also indicated a growing sensitivity to A$ strength and longer dated yields. Flagging larger central bank balance sheet increases in other countries and the ACGB 10yr yield remaining high on a relative basis. Perhaps a nod to their trans-Tasman fellows at the RBNZ who have been more proactive in their policy responses. In addition, a recognition of the role a weaker currency could play in policy transmission. In our view this was confirmation of a shift toward outright quantitative easing with the intent of lowering longer dated yields. The market certainly agreed and over the past month these spreads have narrowed somewhat.
The Governor did flag the potential drawbacks to further policy easing centred around financial stability concerns, but went on to emphasise the near term risks to financial stability posed by labour market conditions and private sector balance sheets vs. the longer term concerns surrounding inflated asset prices and speculation. This aligns with the Fed communications suggesting there’s a trade-off coming between jobs and incentivising speculation in housing and financial markets. In that trade off, the winner for central banks is the labour market, alongside progress toward long-term objectives of full employment and meeting inflation targets.
As, we have previously outlined, taken together the commentary signals a readiness to continue to support the recovery with the tools available, via further easing of monetary policy – greenlighting the move on November 3, when the board next meets.
With little reason to wait, we expect at the next board meeting in November a 15bp cut in the cash rate, YCC target and TFF rate to 10bps and the announcement of an outright, open-ended QE package purchasing longer dated securities in the 5-10yr range, with the broad intent of lowering longer dated yields. The board could commit to open-ended purchases of securities with longer maturities until inflation has returned to target/labour market conditions are improved.
What does more easing mean for portfolios
Rate cuts support the property market at the margin, making housing more affordable, supporting both sentiment and demand. However, 2020 is a year unlike any other. The jobs market will be key to the property market over the next year, alongside the stall in immigration which will place downwards pressure on prices. Higher unemployment and weaker economic growth therefore have the capacity to offset the impact of reducing interest rates. The effect of the pandemic also sees regional bifurcations, for example the Melbourne market, worst affected by the virus, will be weaker than other cities. But also, other trends are emerging post COVID as the shift to working from home allows people to live outside of the city in regional locales buoying certain regional markets.
For the equity market, continued policy easing from the central bank entrenches the ongoing search for yield. Investors continue to be pushed up the risk spectrum hunting for returns and savers are effectively penalised. This dynamic, all else being equal, supports the share market, particularly growth and quality stocks.
The shift toward an outright QE package has the capacity to accentuate these dynamics. We have seen in recent years as central banks around the world have increasingly adopted unconventional easing measures that QE works to inflate asset prices and not wages.
The other precipitous shift detailed an abandonment of policy orthodoxy, “putting a greater weight on actual, not forecast, inflation”, moving towards an AIT-esque regime. The RBA is joining the Fed in pivoting toward a monetary regime where the economy and inflation will be allowed to run hot in order to support inflation expectations. An inflationary environment, if achieved, supports commodities and hard asset investments. An inflationary regime with central banks continuing to pursue unconventional policy measures would also have implications for traditional weightings to government bonds within diversified portfolios, particularly with yields at a very low starting point. Suggesting that investors may be better off increasing weightings towards inflation-linked bonds, precious metals, base metals and agricultural commodities within diversified portfolios.
The central bank’s stance is not the only driver of the AUD, but all else equal, the enhanced forward guidance from the RBA and openness to ease policy settings further, places downward pressure on the AUD. This could see the AUD underperforming in the G10 FX space in anticipation of the next move from the RBA, however this local dynamic is already well known/priced.
In addition, for the AUD there are always other factors in play, like global risk sentiment, China sentiment and Yuan strength, and global commodity prices. There is also an added complication, as most central banks globally are pursuing aggressive policy easing, with the RBA somewhat behind the curve in this respect, relative to global peers – the outlier for the wrong reason with respect to currency strength (hence the move).
Over the past week with COVID fears and fresh lockdowns weighing, the US fiscal deal dead and the election drawing close the AUD has not been immune to fragile risk sentiment, particularly with the prospects of further easing from the RBA next week in the background.
In the near term, global risk sentiment, tightening restrictions in Europe and in particular the US election will continue to buffet the A$ with the added burden of the RBA’s dovish stance and incoming policy pivot. Clearly, a hurdle will be clarity surrounding the US election with little directional conviction ahead of election week, which entails heavy event risk, its likely to be more of the same choppy trade. However, once there is some certainty on the outcome of the US presidential race, we favour a resumption of the reflationary move for the A$ and view near term volatility as an opportunity, taking advantage of corrections to add to long positioning,