RBA firing blanks and out of bullets; Treasury the cavalry
The Reserve Bank of Australia’s (RBA) March 2020 50bps of rate cuts and 0.25% target yield for the 3-year Commonwealth bond has been overshadowed by rate cuts of 65-150bps and quantitative easing (QE) programs of 3.3-8.5% of GDP by the world’s major central banks.
This new easing by the RBA follows a 75bps easing cycle in June-October 2019, which was supported by both an easing of standards by APRA and the Federal Government’s tax rebate. That stimulus has proven ineffective even before the COVID-19 shock, with seven of nine key indicators weak and private domestic demand flat year-on-year.
We see little prospect for this new monetary easing to be more effective, and so see the burden of policy now firmly on fiscal support and stimulus. In our view, an effective counterattack in the war on COVID-19 entails five factors:
- containment measures limiting the economic impact of COVID-19 to 15-20% of GDP for 2-3 months, or 3-4% of annual GDP;
- monetary support and stimulus – in the RBA’s case this should primarily be support, ensuring liquidity for markets and small businesses;
- fiscal support offsetting most of the 3-4% hit to GDP from COVID-19, minimising job losses and business collapses;
- fiscal stimulus of 1-2% of GDP as the economy stabilises – this should help unleash pent-up demand; and
- the oil price windfall of ~1% of GDP.
Market implications: In the short term, we are watching for a slowdown in new cases in the West to turn positive on equity markets. Vaccine or treatment breakthroughs are other possible catalysts. For longer-term investors who can look beyond current volatility, the gross dividend yield-interest rate gap of 4-5% p.a., even assuming a 25% dividend cut, extreme policy support and an eventual recovery, offers material upside. Well-positioned businesses with strong balance sheets should emerge from this shock in strong shape.