The risk of a credit crunch is real and rising and with the housing market now falling sharply, and economic data deteriorating, Australia’s central bank signalled it will slash rates twice this year.
In a speech on Tuesday, Reserve Bank of Australia governor Philip Lowe signalled a rate cut as unemployment is unlikely to fall; inflation will remain low and wage growth is non-existent.
But at the Fiduciary Investors Symposium, Amy Xie Patrick, portfolio manager, Pendal Group went a step further and predicted the RBA would embrace quantitative easing (QE) once rates fell to 1 per cent.
“This is a way for the RBA to engage in QE in a very specific way,” Patrick told conference-goers.
“QE will be most effective if the RBA targets the buyback of residential mortgage-backed securities (RMBS) since that specifically lowers the rate of borrowing for consumers.
“The RBA doesn’t want to fuel another property boom cycle but they want to put money in the pockets of borrowers as they are feeling quite stretched,” she said.
Patrick stated the high level of household debt makes Australia’s adoption of QE inevitable.
“High household debt is an issue for most markets but Australia’s debt combined with the housing downturn is fuelling concerns that consumers just aren’t willing to borrow.”
The portfolio manager pointed out that central banks around the world heaved a collective sigh of relief when the US Federal Reserve hiked rates earlier this year as it imposed tightening conditions on the rest of the world.
“However, with the recent escalation in tensions between US and China, investors worry that things will get worse which is why we are hearing more about modern monetary theory,” she explained.
“MMT has risen to prominence as it deals with a low or zero interest rate environment and very low inflation. Importantly, she added, MMT also supports a large fiscal expansion as well as moves by central banks to print enough money to service or repay debt.
“MMT is coming to the fore since there is a perception is that what can be done in the policy space is limited.”
According to Patrick, the MMT argument has grown too because the monetary policy experience has failed to deliver equitable outcomes. Rather it fuelled asset inflation.
“Right now, with the prospects of a trade war looming again and China devaluing its currency, if things get a lot worse the support behind MMT will get a lot more serious,” she said.
“A combination of traditional and extraordinary monetary policy along with quite proactive fiscal policy will be needed.”
During the session on fixed interest the portfolio manager listed the opportunities in the debt markets.
Patrick said bonds still have an important role to play in larger portfolios where risk drivers are balanced.
“The Fed’s move to average inflation targeting quite clearly signalled they are willing for the economy to run a bit hotter than usual,” she noted.
“They have signalled that the hurdle for cutting rates is much lower than the hurdle for hiking rates again.”
Nevertheless, she predicted, even if the Fed is on an extended pause, the yield curve will steepen especially in the US as investors sell off bonds as global markets remained unsettled.
The delegates heard that she likes to be overweight government interest rates where policy makers still have a bit of room to move.
“The US had the only real hiking cycle –and we are of the view that the consumer is so weak business capex will turner weaker in the second half of the year and the Fed will cut rates.”
In Australia, however, Patrick is very conscious of value and said the market had already priced in rate cuts in June.
“That said, where policy rates are very low, or even negative, the market has a tendency to price in some kind future normalisation.”
At the riskier end of the fixed interest market she prefers Aussie investment grade paper to global credit which she said is “a bit trickier”.
She is wary of US investment grade bonds and their failure to offer safety.
“You’ve got rating migration from a single-A to triple-B which is just inside the investment grade category and sits just above high yield.”
“Moreover, issuers are not feeling a need to shore up their balance sheets and defend the higher rating.”
Patrick also identified pockets of opportunities in emerging markets – in bonds that are a little higher yielding and consequently more risky.
The session was moderated by Kim Bowater, director of consulting, Frontier Advisors.
