It’s a long way from here to full employment- the RBA is happy with progress but it’s still early days

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The RBA hasn’t purchased any bonds since early May. This means that so far it has ‘only’ bought roughly $50B of government bonds – far fewer than initially expected – under its yield curve control (YCC) policy which aims to keep the 3 year government bond yield at about 0.25% and ensure smooth functioning of the bond market.

Although we were skeptical that targeting the 3 year yield would be sufficient to control the yield curve, so far the RBA’s approach has been successful. Indeed, other central banks, including the Fed, are studying the RBA’s ‘price-rather-than-quantity’ approach to buying bonds with a view to adopting it themselves. 

On other measures the RBA should be cautiously optimistic too. Fiscal policy has swung into gear as Gov Lowe had repeatedly urged. The income support provided, along with Australia’s early effectiveness in controlling the virus, has meant the economic hole has been shallower than feared.    

However, the RBA will know it’s still early days and won’t be counting any chickens yet. It’s a long way from here to full employment and higher inflation. While stimulus has papered over plenty of cracks, it will roll off over time. Hopefully this occurs in a measured way, however it’s still likely that plenty of businesses will fail and unemployment will stay high, and business restructuring will be disruptive. 

The RBA are largely out of options when it comes to interest rate policy. The cash rate is effectively at zero, they have all but ruled out negative interest rates, and via their conduct of YCC the bank has indicated reluctance to be more involved in the bond market. Consequently, their efforts to weaken the AUD by narrowing our interest rate differential to other countries have also largely played out. From here the RBA is most able to provide additional support to the recovery via credit provision – and they are expecting the banks will make more use of the Term Funding Facility. 

The RBA needs to, and will, stay accommodative for a long time, but it’s mostly fiscal policy doing the lifting from here. We don’t think increased bond supply will cause too many problems for the bond market, at least until the economy improves. We continue to like Australian bonds versus offshore peers, as our valuations are more attractive and the policy environment is more certain.  

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