The relatively strong reaction from the Reserve Bank of Australia (RBA) and the implementation of the quantitative easing (QE) policy in order to restore liquidity should help stabilise the bond market, according to Nikko AM’s portfolio manager Chris Rands.
He said that, although it was yet to be determined how the implementation of the QE policy would affect the broader economy, the measures would definitely help the bond market.
“While it is far too early to calculate the potential impact on the economy, this monetary policy, combined with the federal Government’s spending on businesses, should help soften the impact of the coronavirus on businesses that are currently solvent but facing the prospect of a liquidity problem,” he said.
The policy could also help alleviate bad debts in the banking sector, as profitable businesses would be able to be have their loans rolled over and then funded via cheap finance by the RBA.
“It’s obviously too early to determine whether this will directly affect credit spreads, but at the margin in the near term it should be positive,” he added.
Rands stressed that the RBA cut the cash rate to 0.25%, joining the myriad of other developed economies that have moved to zero rates but previously it told markets that 0.25% would be the effective lower bound — the level the cash rate cannot fall through.
“While we are somewhat suspicious of this being the actual lower bound, given how many countries have gone negative as conditions deteriorated, this means that for the foreseeable future cash rates will be almost zero,” he notes.
“This means we can now expect a 0.25% cash rate for the foreseeable future and not expect the cash rate to rise anytime soon.
“As we have previously written, the cash rate is a key input for how we think about bond yields, as 10-year bonds typically trade within a +0.25 to +1.50% range of cash. In fact, since 1995 the 10-year bond has been within this range in 70% of months, with bonds 1.5% above cash in only 13% of months.”
As far as unemployment was concerned, Nikko AM assumed that the RBA was “some time away” from achieving both sustainable 2% – 3% inflation and returning to full employment, given businesses struggled due to social distancing and commodity prices were falling. Following this, wages would be expected to soften due to the business environment.