Wednesday 25 March 2020 by Andrew Mayes Trade opportunities

The RBA goes unconventional

In light of the unprecedented events we are facing from the COVID-19 epidemic, the Reserve Bank of Australia has announced a series of measures intended to prop up the Australian economy and ensure banks and other financial institutions continue to have access to liquidity.

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We have reproduced below the executive summary of a recent article published on the measures announced by the Reserve Bank of Australia last week. To access the full version, please click here.

  • With financial markets convulsing and central banks (and governments) hastily responding with both conventional and unconventional measures, the Reserve Bank of Australia (RBA) has announced its response to COVID-19.
  • Having lowered the cash rate to 0.25% on 19 March 2020, the RBA announced it will also purchase government securities (across the yield curve) in an effort to target a yield on 3-year Australian Government bonds of around 0.25%. By not specifying a particular quantity of bonds it will purchase, the RBA is opting to achieve its objective through the use of yield curve control. Put simply, yield curve control is concerned with the price of bonds; quantitative easing is concerned with the quantity of bonds.
  • The RBA also reiterated and extended its support for interbank liquidity. Following similar actions taken by the New York Federal Reserve as well as the European Central Bank and Bank of England, the RBA has responded to the rising tension amongst interbank funding by injecting increasing amounts of cash into the banking system through its repurchase (or ‘repo’) arrangements.
  • It has also announced the provision of at least AUD90bn in funding for banks at 0.25% (in return for eligible collateral - explored further below), with further funding available if directed toward small business customers.
  • One unique feature of current markets is the sell-off (or liquidation) of both bonds and equities. There appear to be two main reasons for this. Firstly, the growing risk of a health (and economic) crisis morphing into a credit crisis. Secondly, and relatedly, there appears to be a rush for cash (especially US-dollars) on expectations of liquidity shortfalls.
  • The impact of yield curve control by the RBA is generally greatest on the particular rate (or maturity) at which it intervenes. As such, we expect yields at the shorter-end of the Australian government yield curve remain anchored for an extended period of time. Given this, we believe the following should be considered (rationale provided further below):
    • Shorter duration
    • Inflation linked bonds
    • Higher-rated credits
    • Selective high-yield (fixed and floating)

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