In early September, however, there are signs that the rally in risk assets may have pushed too far too fast. Covid-19 infection rates in many parts of the world are proving hard to suppress causing delays or reversal re-opening social and business activity. Geopolitical concerns are weighing more heavily as well amid an increasingly fractious US presidential election campaign and with a marked worsening of China’s international relationships including with the United States and Australia.
Returning to the month of August, major share markets all showed good gains ranging from 1.1% for Britain’s FTSE 100 to 7.0% for the US S&P 500 taking it to a record high. In Australia, the ASX 200 rose by 2.2% notwithstanding the blow to economic recovery prospects with Melbourne in stage 4 lock-down and regional Victoria in stage 3 lock-down through the entire month.
Credit markets rallied again in August and remain assisted broadly as central banks around the world continue to declare they are prepared to support bond and credit markets for as long as it takes to foster economic recovery.
In Australia, any potential “paying of the piper” where deep recession leads to rising household and business defaults and bankruptcies has been deferred and ameliorated by holidays on loan repayments (extended in some cases to at least the end of 2020) as well as higher thresholds to be met before bankruptcy proceedings can proceed (provisions just extended to the end of 2020).
While provision of loan repayment holidays and changes to bankruptcy provisions can be extended further beyond the end of 2020 in need, these arrangements are essentially stop-gap measures that defer potential underlying credit problems until a later date. What has made a more enduring difference to credit dynamics in the current deep recession is the Government’s large-scale income support measures for businesses and households.
In Q2 while real GDP fell by 7.0% q-o-q, the worst quarterly fall since the 1930s depression, household disposable income rose 2.2% q-o-q and the gross operating surplus of private non-financial corporations (profits) rose by 14.9% q-o-q. The large jump in household income and business profits in Q2 was driven entirely by Government income support measures and those are set to taper down from later this month even while Covid-19 restrictions continue to restrain economic activity in Victoria in particular.
While credit and risk assets enjoyed a hope of economic recovery tailwind in August, safe-haven Government bonds became less attractive to investors. Most central banks, including the US Federal Reserve and the RBA, reaffirmed during the month their commitment to a protracted period of low official interest rates and bond buying support. Longer-term bond yields, however, rose during August and bond yield curves steepened to reflect a burst of brighter recovery prospects. The US 10-year bond yield rose by 17 basis points (bps) to 0.70% in August while the 30-year Treasury yield rose by 28bps to 1.47%.
In Australia, longer-term bond yields also rose in August notwithstanding the dour latest economic forecasts contained in the RBA’s quarterly Monetary Policy Statement showing patchy and slow economic recovery through to the end of 2022 with unemployment slow to reduce and inflation staying stubbornly low. The 10-year bond yield rose by 17bps during the month to 0.98% while the 3-year bond yield hovered near 0.25% protected by the RBA’s buying program.
The RBA confirmed all aspects of monetary stimulus at its early August policy meeting, including the 25bps official cash rate and 25bps 3-year bond yield cap. At its 1 September policy meeting the RBA also extended the amount of its 25bps term funding facility to ADIs to help support lending. The RBA intends to provide further monetary support if it proves necessary and the way Australia’s economic recovery is shaping up as a slow, bumpy affair more monetary stimulus may prove necessary.
At the very least, the RBA is likely to maintain the caps on the cash rate and the 3-year bond yield at 25bps through 2021 and 2022 given their current economic forecasts and potential downside risks heightened by the protracted Victorian lock-down. Also, the latest extension to the term funding facility may not be the last. The fact that the soft economic outlook may require even easier monetary conditions at some stage would seem to indicate longer-term Australian bond yields will retrace their August rise over the next month or two.