The RBA is financing the Australian government as well as pumping the housing market

by Shaun Richards

It is time for another trip to a land down under as even commodity rich Australia has found its economy affected by the Covid-19 pandemic. It raises a wry smile as I used to regularly reply to the World Economic Forum which periodically trumpeted Australia’s lack of a recession that with its enormous resources that was hardly a surprise and thus meant little about economic policy. However we eventually found something which did create a recession. From the Reserve Bank of Australia earlier.

The Australian economy is going through a very difficult period and is experiencing the biggest contraction since the 1930s. As difficult as this is, the downturn is not as severe as earlier expected and a recovery is now underway in most of Australia. This recovery is, however, likely to be both uneven and bumpy, with the coronavirus outbreak in Victoria having a major effect on the Victorian economy.

I would be careful about saying things are not as bad as expected after the reverse in Victoria if I was the RBA. So let us send our best wishes to those affected there as we note the detailed breakdown of the forecasts.

In the baseline scenario, output falls by 6 per cent over 2020 and then grows by 5 per cent over the following year. In this scenario, the unemployment rate rises to around 10 per cent later in 2020 due to further job losses in Victoria and more people elsewhere in Australia looking for jobs. Over the following couple of years, the unemployment rate is expected to decline gradually to around 7 per cent.

So they are expecting lower falls than in Europe but there is a familiar rebound next year which frankly feels based on Zebedee from The Magic Roundabout rather than any grounding in reality.

Financing The Government

Like so often this is what it boils down too.

At its meeting today, the Board decided to maintain the current policy settings, including the targets for the cash rate and the yield on 3-year Australian Government bonds of 25 basis points.

So even resources rich Australia found itself unable to resist the supermassive black hole pull of ZIRP and central bankers being pack animals. I suspect as I shall explain in a minute they have stopped slightly short of 0% because of fears for the banking sector. But the crucial point we are noting here is the control agenda for the bond market which mimics in concept if not level that applied by the Bank of Japan.

Why does the government need financing? Well there is this.

Government bond markets are functioning normally alongside a significant increase in issuance.

As to how much the Australian Office of Financial Management reinforced this last week.

On the 3rd of July we announced a weekly issuance rate for Treasury Bonds of $4-5 billion, with a weekly rate of issuance for Treasury Notes of $2-4 billion. We are confident this guidance will be reliable until the October Budget; absent of course a sharp unanticipated change in the fiscal position.

The major shift in fiscal policy is highlighted here.

Although to date we have only announced a weekly issuance rate and new maturities, the current plan for gross Treasury Bond issuance this year is around $240 billion.  This will comprise about $50 billion to fund maturing debt and $190 billion of net new issuance.  This is materially higher than the $128 billion issued last year, although almost $90 billion of that was issued in the last quarter.

So a near doubling as they went from not being that bothered about issuing debt.

Less than six months ago the AOFM was rationing issuance to best manage a market maintenance objective.

To a spell when they could not issue at all.

Temporary loss of access to funding markets is certainly something we had thought possible (and indeed likely at some point), but combined with the scale and timing of the increased pandemic financing task it was a more sobering experience than we could have imagined.

They would have been burning the midnight oil before International Rescue arrived.

We will never know how long the market would have taken to recover had the RBA not intervened.

If we return to the RBA statement let me present you with two outright lies.

Government bond markets are functioning normally alongside a significant increase in issuance.

If they are then why is this needed?

The yield has, however, been a little higher than 25 basis points over recent weeks. Given this, tomorrow the Bank will purchase AGS in the secondary market to ensure that the yield on 3-year bonds remains consistent with the target. Further purchases will be undertaken as necessary.

Then the next lie.

The yield target will remain in place until progress is being made towards the goals for full employment and inflation.

Actually it will remain in place until the government no longer needs financing. This may be open ended as we note that the only place which has this ( Japan) only ever seems to do more and never less. The initial salvo in Australia was this.

To date, the Reserve Bank has bought around $47 billion of government bonds ( April 21st)

The Precious! The Precious!

In another example of pack animal behaviour they have pretty much copied and pasted a Bank of England policy.

The Reserve Bank has established a Term Funding Facility (TFF) to offer three-year funding to authorised deposit-taking institutions (ADIs).

So they are avoiding calling them banks. Oh and whilst they get this.

to reinforce the benefits to the economy of a lower cash rate, by reducing the funding costs of ADIs and in turn helping to reduce interest rates for borrowers.

You may note how bank costs are “reduced” whereas it is “helping to reduce” them for others. We know who it will help and it is not these.

The scheme encourages lending to all businesses, although the incentives are stronger for small and medium-sized enterprises (SMEs).

Well not unless they are in the mortgage or house price market. For those unaware of the UK situation when the policies were applied here small business lending did nothing but in a “completely unexpected development” mortgage rates plunged and lending surged.

So far just over 27 billion Australian Dollars have been supplied via this route.

Comment

Much here is familiar as we see a central bank implicitly financing its government and pumping up the housing market too. The RBA must have thought all its Christmases had come at once when the Aussie bond market had trouble at the shorter maturities and it could intervene at a place likely to impact on mortgage rates. It must feel the banks need help or it would have cut the official rate to 0%.

Thus has led to a money supply surge with narrow money going from 909 billion in June of last year to 1260 billion on June of this. Quite a shift for an aggregate which we had noted in the past was going nowhere and at times had fallen.

Switching to external events the Aussie Dollar or as some call it the little battler has been doing well. The trade weighted index which went as low as 49.9 on a day familiar to regular readers but the 19th of March for newer ones is now 61.4. As for influences I guess the relative hopes for the economy are in play as well as this.

Preliminary estimates for July indicate that the index increased by 0.9 per cent (on a monthly average basis) in SDR terms, after decreasing by 0.2 per cent in June (revised). The non-rural and base metals sub-indices increased in the month, while the rural sub-index decreased. In Australian dollar terms, the index decreased by 0.2 per cent in July.

Over the past year, the index has decreased by 12 per cent in SDR terms, led by lower coal, iron ore, LNG and oil prices. The index has decreased by 12.1 per cent in Australian dollar terms. ( RBA earlier today)

So an improvement for the resources base and looking ahead Gold is 7.5% of the index. Although the compilers of the index have just reduced its weight from 8.7% and will now find themselves in the deepest dark recesses of the RBA bunker where the cake trolley never goes.