The Perils Of Normalization

Not all “notables” make for the most exciting reading. In fact, some notables are downright bland. Similarly, not all things that make for “good” reading are actually notable — just ask any successful tabloid.

Nevertheless, I feel obligated to mention important developments even if they’re not likely to spark much in the way of debate or otherwise give anyone an adrenaline rush.

With that as the (mercifully brief) lead-in, the RBA went ahead with plans to taper asset purchases on Tuesday, even as the bank extended QE and reiterated that rates are likely to stay parked at record lows for the foreseeable future, where that means into 2024.

“The Board… will not increase the cash rate until actual inflation is sustainably within the 2 to 3% target range,” the July statement read. “The Bank’s central scenario for the economy is that this condition will not be met before 2024,” the RBA went on to say, adding that “meeting it will require the labor market to be tight enough to generate wage growth that is materially higher than it is currently.”

The tweaked QE plan calls for purchases of A$4 billion per week of longer-dated securities through at least mid-November, following the expiration of the current iteration of QE in September. The A$4 billion pace represents an A$1 billion taper.

Additionally, the RBA won’t roll the three-year yield target to the November 2024 bond. The Board will “retain the April 2024 bond as the bond for the yield target and retain the target of 10 basis points,” the statement said. That decision, Lowe remarked, was based on what he described as a wider distribution of scenarios for the cash rate due to improvement in the domestic economy.

Again, I recognize that’s all pretty dry, but it’s hawkish at the margins. For example, when Lowe stressed data dependency, three-year yields jumped. “I want to reemphasize that the condition for an increase in the cash rate depends upon the data, not the date,” he said. A hodgepodge of soundbites from Lowe around the same time were mostly seen as hawkish. Australia, he said, is in a “much better” place economically than expected.

Both the Aussie and the kiwi gained Tuesday, with the latter benefiting from an upbeat read on a business survey from the New Zealand Institute of Economic Research.

“The latest [survey] shows a sharp improvement in both business confidence and demand in firms’ own business,” NZIER remarked, noting that “a net 10% of businesses expect an improvement in the economic outlook on a seasonally adjusted basis – a turnaround from the net 8% of businesses who had expected a deterioration in the previous quarter.”

A net 26% of businesses reported increased demand. NZIER said the results “suggest the recovery in the New Zealand economy will remain robust over the coming year.”

Importantly, the results betrayed what the NZIER described as “the most acute labor shortages [in] the history of” the survey.

“We read [the RBA] as surrendering only slightly more ground on QE [and] forward guidance than the market expected,” Credit Agricole’s Valentin Marinov said Tuesday, attributing Aussie gains to the “rapid shift” in expectations around policy in New Zealand. He added that,

The tightness in NZ’s labor market reflects not only strong demand, but also the problems being generated by NZ’s closed international borders and the lack of labor supply coming from foreign workers. The difficulty for the RBNZ will be deciding whether or not this labor shortage is temporary or will be more prolonged and something it should respond to. After all, it is a supply-side issue. This will require the central bank to make assumptions on the opening up of the NZ’s international border and the return of immigrant labor.

All of the above underscores the difficulty central banks face in attempting to chart a course for policy at a time when it’s impossible to say whether what, on the surface, appear to be rapidly improving economic conditions, are sustainable.

The same goes for labor market frictions and price pressures.

This is complicated (immeasurably) by the necessity of calibrating policy appropriately vis-à-vis the Fed. Depending on where you are in your own recovery and how your currency is trading, you may want to be behind, ahead or in-step with Jerome Powell.

“We expect the Fed will announce its intention to begin tapering its bond purchases in September,” Westpac said Tuesday. “The Fed’s actions, once begun, will give the RBA cover should it decide to curtail its purchases even earlier than our expectation of around mid-2022,” the bank added, noting that the RBA’s “decision to not extend the yield curve target program to the November 2024 bonds [is] a decision to further tighten policy.”