“I have always believed that the way you treat your employees is the way they will treat your customers and that people flourish when they are praised” Richard Branson
On the home front, the RBA surprised the market after its August meeting by retaining its bond tapering mechanism ahead of the current programs Sep 3 expiry. This goes against most market views that the QE (Quantitative Easing) program should be increased, largely because of what is happening around the country because of COVID. If nothing else this just goes to support the view that once again interest rates are not going anywhere anytime soon. As far as economic growth, Westpac are forecasting that the Australian economy will contract by 2.2% in the September quarter due to the extended lock down in Sydney and a renewed lock down in Melbourne.
The factor most affecting economic decision making now is of course COVID and much, if not all, will hinge on vaccination levels, particularly in NSW. For example, the timing of the reopening of NSW is based on forecasts of when NSW will hit full vaccinations levels of 80% for 16-year-olds and older. The reopening of NSW is not based on the achievement of extremely low new cases but more so vaccination rates. If achieved, hopefully this will give the state/s the ability to start relaxing some of the restrictive health measures currently in place.
It has been surprising that on the back of this current COVID variant, risk assets have been incredibly resilient in the face of increasing economic uncertainty. The belief that once again central banks will come to the party and sell a free put to investors could start to waver based on recent moves in the currency and equity markets. The reality is we are fighting an invisible enemy and the immediate future will remain very fluid. As the old saying goes – one can never go broke taking profits in risk assets and placing them into bonds so you can sleep well.
Further afield in the US, the minutes of the July FOMC meeting provided a constructive view of the economic outlook and continued to point to a taper announcement from the FOMC in September, also apparent was a desire to recognise risks and adapt policy. Since then, the US and global Delta outbreaks have intensified, and some indicators of sentiment and consumer spending have wavered. The effect of this current outbreak on US consumer sentiment and spending will be critical for the outlook for both monetary policy and the US dollar. Next Friday will provide a pivotal update on the outlook for the economy and policy, with FOMC Chair Powell to speak at the Jackson Hole Symposium.
Below is a chart of the US 10 Year Govt Bond over the period Mar 21 to Jun 21. The bond market has become surprisingly quiet in the past few months. Ten-year Treasury yields have settled into a narrow range near 1.6%, after peaking at 1.74% on March 31st, a steep rise from less than 1% at the start of the year. The market has shrugged off wide swings in the economic data, a spike in inflation readings, and uncertainty about the direction of fiscal and monetary policies.
The issue most people see is that bond yields at current levels are not consistent with the likelihood of continued strong economic growth, and the risk of higher inflation. Even if economic growth and inflation revert to pre-pandemic levels over the next year, yields still appear low and offer little room for error. Considering the unprecedented fiscal stimulus in place to boost economic growth and the Federal Reserve’s willingness to tolerate higher inflation, there is room for bond yields to move up in the second half of the year. That said and just like in Australia, short term interest rates should remain at current levels for the short to medium term.
The chart below gives us an idea of just how big the Feds QE program has been and certainly puts things into perspective for other central banks such as the RBA. The Feds holdings are now more than US$7 trillion!!!
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