Westpac has revised up its profile for the RBA’s Quantitative Easing Program. We now expect the new program which starts in April to be followed by a further $100 billion (up from our earlier forecast of $50 billion).
On December 14 last year we surprised markets by forecasting that once the Bank’s current $100 billion QE program was completed in 2021 it would be replaced by a further program of $100 billion to be followed by two consecutive $50 billion programs.
Those programs would extend the QE facility out to around October 2022.
On February 2 this year the RBA Governor announced that the program, which was scheduled to be completed around mid- April 2021, would be extended by a further $100 billion on the same terms as the current program.
We now expect that the program that is scheduled to begin in mid-April and extend into mid-October will be replaced by another $100 billion program rather than the $50 billion which we forecast back in December.
We maintain the call that the final “leg” of the program will be tapered to $50 billion from April next year.
The FED”s QE policy will be a very important sign post for the RBA.
It is unlikely that the FED will have made sufficient progress towards its goals by October this year to warrant scaling back its asset purchases.
Were the RBA to taper it will expose the AUD and signal to the market that it has begun tightening.
Such a signal could expose the recovery to unnecessary pressure and cast doubt on the credibility of any forward guidance the RBA may be offering.
Recall that when the RBA Governor announced the extension of the first QE tranche of $100 billion he nominated three criteria (February 3, National Press Club).
- The effectiveness of the bond purchases;
- The decisions of other central banks; and
- Most importantly, the outlook for inflation and jobs
“With three months experience now, it is clear that the bond purchase program has helped to lower interest rates and has meant that the Australian dollar is lower than it otherwise would have been. So, it has worked. Australia’s government bond markets also continue to function well and the available evidence is that further purchases would not be a source of market dysfunction.
In terms of other central banks, most have recently announced extensions of their bond purchase programs, many running until at least the end of this year. Given this, if we were to cease bond purchases in April, it is likely that there would be unwelcome upward pressure on the exchange rate.
And, third, in terms of the most important consideration – the outlooks for inflation and jobs – we remain well short of our goals, as I have already discussed
Given these considerations and the fact that the cash rate is at its effective lower bound, the Board decided to purchase an additional $100 billion of government bonds at the completion of the current program in mid-April.”
Backing up these views, Chris Kent, Assistant Governor, Financial Markets, stated “While history only provides a rough guide, …the Bank’s policy measures have contributed to the Australian dollar being as much as 5% below otherwise”. (February 17; Australian Corporate Treasury Round Table).
The Bank also has a reasonable case to argue that QE has lowered Australian long bond rates by around 30 basis points. Before the market detected the RBA’s interest in QE back in early September AUD long bond yields were 30 basis points above US while on November 3 when the QE policy was announced the rates had become aligned.
The Governor also referred to market disfunction related to QE detracting from liquidity in the bond market.
In the December Mid-Year Economic and Fiscal Outlook (MYEFO) the federal government forecast that the budget deficit would be $197.7 billion in 2020/21 to be followed by $108.5 billion in 2021/22.
Both those numbers are likely to be revised down significantly as the recovery in the economy lowers the expected deficits. (media coverage today pointing to an official downward estimate for 2020/21 to $150.6 billion).
The MYEFO estimates for the deficit in 2021/22 are likely to be similarly revised downward. These revised estimates will have a significant impact on forecast new issuance in 2021/22.
But MYEFO is a “no policy change” document.
We can expect the federal government to adopt a range of stimulatory policies aimed at assisting those sectors which are still being impacted by foreign border closures. The government is also likely to take advantage of the fiscal flexibility which comes with not being constrained to produce a surplus – the “discipline” faced by all Australian governments in the years before the pandemic.
Westpac expects a wide range of policy stimulus in the May Budget while the government is likely to be conservative in its estimates of the deficit improvement in 2021/
While RBA purchases will dominate the flow of new issues there is ample existing stock to accommodate the RBA’s activities.
The RBA currently holds around 16% of bonds on issue.
It is true that RBNZ ran into supply problems although the RBNZ holds 35% of bonds in New Zealand. The capacity problems faced by the RBNZ should not be seen as constraints on the RBA.
There is also adequate “room” on the RBA’s balance sheet to accommodate further QE.
Firstly, the $200 billion Term Funding Facility is unlikely to be increased or extended beyond June.
Secondly, by the time the RBA has to make the decision on extending its QE program (September 2021) its balance sheet is estimated to be around 30% of GDP compared to the FED’s balance sheet that will be 40% of GDP.
Finally consider the economic backdrop which we expect by October this year.
RBA’s current forecasts for end 2021 are an unemployment rate of 6%; wages growth of 1.5%; and trimmed mean inflation of 1.25%. Those “actuals” are assessed as consistent with a 5.5% unemployment rate by end 2022; 1.25% wages growth; and 1.5% trimmed mean inflation.
The RBA is certain to reduce its forecast for the unemployment rate by end 2021 , probably to around 5.7%.
But it seems unlikely that , with a 4–4.5% NAIRU in their thinking there will be sufficient improvement in the labour market to encourage a marked lift in the forecast for wages growth and inflation.
(Note that the RBA Deputy Governor further raised the bar at a Senate Hearing today referring to a preferred NAIRU of “high 3’s – low 4’s”).
It seems highly unlikely that the RBA will see the justification for tapering QE as early as October when the achievement of its objectives is so far into the future.
The AUD is expected to continue to pose a challenge for the RBA. Westpac forecasts that the AUD is likely to be on the rise in the second half of 2021. As economies reopen and global growth accelerates “risk on” currencies like the AUD are expected to be supported.
We already see the AUD as undervalued relative to our fair value estimates (possibly partly due to QE) and expect it to be moving through to USD0.82 in the second half of 2021.
QE will continue to be seen by the RBA as an important source of restraint on the AUD during that period.
One potential complication to the forecast.
While not our central call it should not be dismissed out of hand that the RBA would revert to a more flexible program from October by committing to an open ended monthly target of, say, $20 billion, (in line with the current purchase pace).
We understand that the first stage of QE needed to be a finite program as markets adjusted to the new policy and an open ended policy might have generated destabilising uncertainty.
But now that the policy is working smoothly and markets have adjusted the uncertainty risks of adopting an open ended policy have passed.
