Reserve Bank

Reserve Bank set to ramp up bond buying as market braces for Government’s wall of debt

The Reserve Bank is this week expected to double the size of its quantitative easing programme to $60 billion as markets brace for the wall of Government debt likely to be issued to combat the economic effects of the Covid-19 pandemic.

The central bank’s official cash rate review and monetary policy statement is due on Wednesday while the budget is due on Thursday.

The two events would not normally be so closely linked, but this time they are.

This year’s New Zealand $25b Government funding programme was a record – easily beating the previous record of $19b, set in 2011.

Next year’s programme – estimated at $45b – will dwarf that, as will the following year’s.

A flood of new paper would normally put upward pressure on bond yields, which would be at odds with the aim of the Reserve Bank of keeping rates low to help the economy recover from the Covid-19 driven downturn.

Reserve Bank Easing

The bank’s quantitative easing, or bond-buying programme, aims to keep a lid on yields.

ANZ strategist David Croy estimates the QE programme will go to $60b while others put it in a $50b to $60b range

“It’s very difficult to estimate these things,” Croy said.

“There is no economic model that can cope with a 10, 15 or 20 per cent fall in GDP.”

Market participants said it’s been a long time since a budget has been so keenly awaited.
“But that’s entirely appropriate because fiscal policy is doing the heavy lifting, and so it should be,” Croy said.

In the fiscal year to June 30, 2021, Croy expects the Treasury to raise about $45b to fund the likes of the wage subsidy scheme, which has already cost $10b.

Reserve Bank Governor Adrian Orr is not expected to change the official cash rate, which in an emergency move was cut by 75 basis points to just 0.25 per cent on March 16.

At the time Orr said that’s where the rate would remain for at least 12 months and, despite talk of rates going negative, the market sees no reason to doubt his word.

But in accompanying papers, the bank raised questions as to banking system’s “operational readiness” to handle very low or negative interest rates.

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That clause was seen as an instruction to the banks to make their systems ready for such a move, should it become necessary.

The Reserve Bank had its first dab at quantitative easing on March 23, and market participants said the bank’s moves have so far been effective, and had restored some semblance of order to what had been a dysfunctional bond market.

Westpac senior markets strategist Imre Speizer expects government debt to go from 20 per cent of GDP to 50 per cent by 2024 – equating to about $150b to $160b of bond issuance.

Speizer expects the bulk of that debt to be raised over the next two fiscal years.

“Those two years will bear the brunt of it,” he said.

“Given that, the Reserve Bank has got a big job ahead of it to keep the market running smoothly because the market will look ahead to what will be a massive wall of bonds hitting the market,” he said.

“Clearly, the Reserve Bank is going to have to be the backstop.

“To be the backstop, it’s going to have to up its QE programme,” Speizer said.

The Reserve Bank will need to be in the market to avoid market dysfunction.

Covid-19 in NZ — Sunday 10th May
Covid-19 in NZ — Sunday 10th May

If it’s not there, the sheer weight of bond issuance will cause yields to rise, just as they did before the Reserve Bank took action in March.

“And if yields rise a lot, it will run counter to the monetary policy objective.”

There was an outside chance that the Reserve Bank would follow the Reserve Bank of Australia (RBA), which in March said its bond buying would target a specific yield 0.25 per cent for the three year government paper.

Speizer said the RBA’s move had so far proven to be effective, a fact that won’t be lost on the RBNZ.

As Reserve Bank Governor Adrian Orr and Finance Minister Grant Robertson outline the country’s monetary and fiscal responses to Covid-19, they will both be aware of the toll it has already taken here and overseas.

Domestically 1.7 million people are already part of the Government’s wage subsidy scheme.

In the US, data out over the weekend showed unemployment there hit 14.7 per cent – its highest level since World War Two – driven by 20.5 million in new job losses in the month of April alone.

By Jamie Gray

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