Tim Hext’s weekly bond market outlook
Here’s the bond market outlook from Pendal portfolio manager Tim Hext ahead of next week’s interest rate decision. Reported by portfolio specialist Dale Pereira
It’s been an eventful time in the bond market as Australians prepare for Tuesday November 3 – not the Melbourne Cup or the US election, but the RBA statement.
Since early September the RBA has been dropping hints about further easing and the market is now largely priced.
We managed to pick up on the hints and have been well placed for the moves.
A cash rate cut to 0.10% and 3-year Yield Curve Control to 0.10% seem certain. The ES account interest rate (RBA interest on surplus balances) will likely go to 0.01%.
This last one is important because it becomes the effective cash rate as the RBA has left huge surplus balances in the market.
This may see some cash products tip into negative rates. The RBA was keen to avoid this earlier in the year but seems comfortable with it now.
Quantitative Easing (QE) is also likely.
The market expects the RBA to announce a program of some $100 billion of bond buying over the next year.
This will likely be outstandings weighted, meaning about $65 billion in government bonds and $35 billion in semi-government bonds.
This will account for about a quarter of government new issuance and almost half state government new issuance.
This last one is important — Governor Lowe has been very vocal about states needing to collectively spend an extra $50 billion to help the recovery. It might seem rude to urge this and not assist.
Markets are now trading Australian 10-year bonds at flat to US 10-year bonds after an average of 25 basis points over the last six months.
Importantly, the expectation of easing has seen a weaker Australian dollar.
In a recent speech Governor Lowe was explicit in his concerns that higher rates here would make the currency stronger — an outcome no country wants during a recovery.
This shows international factors have a huge impact on our monetary policy.
So come Tuesday November 3, markets expect a rate cut and QE.
Two undecided factors are the interest the RBA will offer on ES Balances and how much and what for QE.
For bond managers like us, how far out the bond curve they buy will be vital for relative value and what we hold.
Modern Monetary Theory
We keep getting asked: “is this Modern Monetary Theory?”
Technically no, but effectively yes.
MMT urges money financing — the RBA printing money and giving it to the government. QE involves the government issuing bonds to the market and the RBA then buying some of them from the market.
The RBA thinks this is a vital distinction, but a casual observer might call it a nuance.
Tim Hext is a portfolio manager with Pendal’s Bond, Income and Defensive Strategies team.
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