Australia to benefit from global search for yield

With Australia on the path to recovery and the second wave apparently arrested, all eyes yesterday were on the Federal government and the RBA as they handed down the Federal budget and rate decision.

While the RBA disappointed, leaving cash rates on hold, the budget delivered a range of measures designed to boost jobs and spending.

With these two key events out of the way, and markets digesting the information contained within, I reached out to David Choi from Aberdeen Standard Investments to get the key points for investors and the economy. Here, he shares the likely economic impacts, potential policy errors, and where he's looking to find yield today.

What were the key takeaways from the recent RBA rate decision and Federal budget?

Ensuring that the economy is on a sustainable path to recovery is the joint focus for the RBA and the Federal government. Since March 2020, we’ve seen unprecedented coordination between monetary and fiscal authorities as well as bank regulators and we view the RBA’s October statement and the Federal budget as an extension of this coordination.

Addressing ‘the high rate of unemployment’ is the focal point for both monetary and fiscal policy. For instance, in the October Statement, the RBA board viewed ‘addressing the high rate of unemployment as an important national priority’. Likewise, it is no co-incidence that the Treasurer, Josh Frydenberg, told the government that ‘this budget is all about jobs’ in introducing a multi-pronged fiscal plan to support the economy.

The budget encourages hiring and business investments. It announced infrastructure funding, and has brought forward income tax cuts to provide an uplift in household disposable income. Temporary loss carry-back provisions will also support struggling businesses.

While the RBA fell short of announcing monetary policy actions at the October meeting, we noted the clear dovish rhetoric which, in our view, foreshadows imminent action in the coming months. We expect the RBA to lower the yield curve target and adopt a quantity-based asset purchase program to help finance the 2020 government budget. In addition, macro-prudential policies will play a supportive role with APRA amending the size of the Committed Liquidity Facility, assisting the market’s digestion of increased government bond issuance. Furthermore, easing responsible lending requirements should assist the supply of credit to households and businesses.

What economic impacts do you expect?

We expect this unprecedented policy coordination to mitigate downside risks to the domestic growth outlook and alleviate concerns about the efficacy of the monetary policy near zero interest rates.

The budget contained Treasury’s economic forecasts that were better than expected. In comparison to the July forecasts, 2020-21 GDP forecast was revised higher to -1.5% from -2.5%.

Were there any points that stood out to you as potential policy errors? What could be the impact?

The fiscal injection is necessary but mismanaging the eventual withdrawal (or ‘fiscal cliff’) creates a potential policy error. Fiscal policy is carrying a heavy load of economic support providing income support to households amid a large unemployment shock and keeping business from closing through rent, payroll relief and wage subsidies.

A sudden halt to this fiscal support, without an underlying economic recovery, will be an undue tightening of financial conditions.

We see the risk as low given the evidence of coordination of policies.

How has this affected government bonds and what do you expect from them in the future?

‘Lower for longer’ remains the dominant medium-term theme. Globally, this theme is not new. However, the search for yield is likely to intensify in Australia as the RBA ventures deeper into the realm of unconventional monetary policy. By mid-2021, the Term Funding Facility will have grown to at least 200bn (10% of GDP, and 8% of total credit outstanding) – a not-so-insignificant liquidity injection. Term deposit rates, senior unsecured financial bond and RMBS yields will drop sharply as the Term Funding Facility substitutes traditional sources of bank wholesale funding. Longer-tenor corporate bonds are attractive in this environment and will be sought after as investors look to lock in reliable sources of income.

Australian bonds also benefit from global demand for yield. Despite a significant rally in Australian government bonds, they still offer one of the highest yields in developed markets. Whilst the budget deficit numbers were staggering, gross government debt to GDP is expected to stabilise at 55% by 2025-26 and is still modest by international standards. As such, Australian government bonds continues offer quality and value for global investors.

Where are you looking to find yield today?

In Australia, we view high quality corporate bonds as attractive, even after the recent rally in credit spreads. The proportion of the overall bond yield being generated by its credit spread is significant, and will entice new investors into the asset class. We also see high quality RMBS securities offering good value at the moment.

We have been tactically trading European High Yield bonds as well as short-duration Asian government bonds. However, in the lead-up to the US election, we have taken profits on these positions and cleaned up positioning based on our expectation of increased volatility in the near-term.

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Important

Issued by Aberdeen Standard Investments Australia Limited ABN 59 002 123 364 AFSL No. 240263. This document has been prepared with care, is based on sources believed to be reliable and all opinions expressed are honestly held as at the applicable date. However it is of a general nature only and we accept no liability for any errors or omissions. It has been prepared without taking into account the particular objectives, financial situation or needs of any investor. It is important that before acting investors should consider their own circumstances, objectives and financial situation, the information’s appropriateness to them and consult financial and tax advisers. You must not copy, modify, sell, distribute, adapt, publish, frame, reproduce or otherwise use any of this material without our prior written consent.