RBA cuts key cash and 3Y yield targets to 0.1%

Chris Scicluna
Equity markets rebound strongly as final countdown to US election begins
Wall St yesterday made a positive start to the week, with the S&P500 rising 1.2% to erase Friday’s losses. While partly a reaction to last week’s heavy selling, sentiment was supported by a string of positive factory sector PMI reports, including the best reading on the US manufacturing ISM since September 2018. That said, nervousness was still evident in the VIX, which closed only slightly lower at a still very elevated 37.1. However, US equity futures have continued to drift a little higher since Wall Street closed, with S&P e-minis up more than ½% as we write. And while markets were closed in Japan today for the Culture Day national holiday, USTs have weakened a little again in early trading in London (10Y yields back up above 0.86%). Equities have started the day on the front foot across the board in Europe, where the day should be relatively quiet for economic news.
Elsewhere in Asia, the key regional bourses all traded higher, with significant gains of close to 2% seen in Hong Kong, South Korea, and Australia. Markets also rallied more than 1% in China and Taiwan. Local economic news was thin on the ground in the region aside from in Australia where – as very widely expected – the RBA announced a further 15bps cut in its key policy rate targets. And as had seemed quite likely, the Bank also announced a program of bond purchases focused on 5-10Y maturities (see plenty more on the RBA below). The realisation of the latter initially sent the 10Y AGS down 6bps to 0.74%, before yields bounced back to 0.77%. Perhaps disappointingly for the RBA, the Aussie dollar weakened only slightly after the announcement.
US elections obviously the focus over the next 24 hours, and probably well beyond
Needless to say the focus for investors over the next 24 hours – and probably well beyond – will be on the US elections. In aggregate, the opinion polls still point to a ‘blue wave’ whereby the Democrats win a clean sweep of the Presidency and both houses of Congress – a scenario that would open the door much wider to extra fiscal stimulus and thus renewed reflationary momentum, among other things putting UST yields under further upwards pressure. But given the experience of 2016, prediction markets are less convinced, giving Trump a chance of victory closer to one-in-three, and the Republicans a greater chance of retaining the Senate.
The first of the key bellwether and/or battleground states to start counting will be Georgia, where polls close at 7pm ET. Polls close 30 minutes later in North Carolina and Ohio, while the key states of Florida and Pennsylvania close at 8pm ET. In Arizona, Michigan, Minnesota, Texas and Wisconsin polls close at 9pm ET. If the result is clear cut, a result could in theory be called as polls close on the West Coast at 11pm ET.
However, if the result is close – as might seem likely in many of the key battleground states – a victor might not be called until much later in the night, if at all. Indeed, the extremely high number of mailed ballots – and the likelihood of a very high turn-out overall – also point to the likelihood that a clear winner is much slower to emerge. And it also raises the significant risk of a legal challenge, with Trump on Sunday stating “We’re going to go in [the] night of, as that election is over, we’re going in with our lawyers.” This all points to the risk of a very volatile session for Asian markets on Wednesday which will be trading as the first results begin to trickle through.
As the largest swing state, and one where election officers have for some time been processing mail ballots, Florida will be one to watch. If it becomes increasingly clear that Trump has lost the sunshine state, expectations of a Biden victory will crystallise. North Carolina, Georgia, Iowa and Ohio are other battleground states that were allowed to process ballots early and thus will be closely watched. In contrast, Pennsylvania – another large swing state – will allow mail-in ballots arriving up to Friday to be counted, and seems both unlikely to be called early and at risk of ongoing legal challenge.
While investors wait for the US polls to close, on the data front today we will receive the full US factory orders report for September together with news on auto sales during October.
RBA cuts key rates to 0.1%, unveils A$100bn of QE focused on 5-10Y bonds
Today’s much-awaited RBA Board policy review provided no major surprises. As had seemed likely, especially in the wake of Governor Lowe’s mid-October speech, the Board cut its cash and 3-year bond rate targets by a further 15bps to a new record low of 0.1%. The rate applicable to new drawings under the Term Funding Facility was also reduced to 0.1%, while the interest rate on Exchange Settlement balances was reduced to zero. In addition, the RBA announced that it intends to purchase a total of A$100bn of government bonds over the next six months, beginning this coming Thursday. Those purchases will be made in the secondary market through regular auctions. The Bank intends to purchase in the 5-10 year part of the curve and anticipates an 80/20 split between commonwealth and semi-government bonds. It is worth noting that any bonds bought to support the achievement of the Bank’s 3Y yield target would be in addition to the program announced today. The clear focus of this policy is to place downward pressure on yields, thus lowering financing costs, supporting asset prices and delivering a weaker Aussie dollar than would otherwise be the case. The Board stated that it will keep the size of the bond purchase program under review and is prepared to do more if necessary.
Notwithstanding today’s policy action, the post-meeting statement makes clear that the RBA’s baseline economic forecast has improved compared with the last forecast made in August, and by more than can be explained by the incremental stimulus added today. The Bank stated that recent data have been a bit better than expected and so GDP growth of around 6%Y/Y is now expected in the year to June 2021 – up from 4%Y/Y previously. The Bank continues to forecast GDP growth of around 4%Y/Y in 2022. Importantly, the unemployment rate – currently at 6.9% – is now expected to peak at around 8%, rather than the 10% rate foreseen previously. The unemployment rate is expected to decline to around 6% by the end of 2022, compared with the forecast of 7.5% previously, although this remains well above the level consistent with full employment. Despite the improved outlook for activity, the Bank now expects underlying inflation to end next year at around 1%Y/Y – down from its current pace of 1¼%Y/Y. However, inflation is expected to pick up to 1½%Y/Y in 2022. Of course, this means that underlying inflation is expected to remain below the lower bound of the Bank’s 2-3% target until at least some time in 2023. Adopting the language foreshadowed by Governor Lowe’s October speech, today’s statement commits the Board to not increasing the cash rate until actual inflation is sustainably within the target range – a process that the Board anticipates will take at least three years given the outlook for the labour market.
Reflecting the significance of today’s policy action, Governor Lowe took the rare step of calling a post-meeting press conference to further explain the Bank’s actions, with Lowe’s substantial opening remarks also published as a speech on the Bank’s website. As foreshadowed in previous comments, Lowe justified the timing of today’s action – at a time when the Bank is raising its growth forecasts – as reflecting the greater traction that policy can be expected to gain now that the economy is reopening. Elsewhere, he sort to head off any suggestion that the RBA is now financing the government. He also explained why the Board had chosen a quantity target for its new QE program rather simply setting a price target for 5Y or longer bonds. Perhaps most importantly, Lowe sort to reassure the public and markets that the Bank is not out of firepower if further stimulus proves to be required. In particular, Lowe emphasised that the Bank could increase its bond purchases, or employ tools such as further liquidity provision, asset purchases and transactions in the FX market. However, Lowe reiterated that there has been no change to the Board's view that there is little to be gained from lowering the policy rate into negative territory, and so a negative policy rate in Australia is “extraordinarily unlikely”.
On Friday the RBA will have the opportunity to further explain its views on the outlook for the economy and policy when it releases its quarterly Statement on Monetary Policy (SMP). However, given the fullness of today’s communication, the SMP in certain to attract less attention than would usually be the case.
Australian consumer confidence continues to move higher
The only economic report in Australia today was the ANZ-Roy Morgan measure of consumer confidence, which increased a further 0.2pts to 99.9 – a 9th consecutive week gain which has lifted the index to its highest level since mid-March. While households were less positive about recent developments in their own financial situation, they were more optimistic about the economic outlook. Indeed the sub-index measuring households’ year-ahead outlook for the economy jumped more than 6pts to 81.7 to the highest level since late February.

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