Mizuho daily - Side-Effects and RBA's thorny challenges

Vishnu Varathan, Head, Economics & Strategy, Asia & Oceania Treasury Department, Mizuho Bank, Ltd.,

Side-Effects

The thing about side-effects is that they inextricable from the medicine. So it is only a question of how severe the expressed side-effects are. For AstraZeneca, incidence of blood clots after usage, whether or not a side-effect, have resulted in a “precautionary” suspension. This has setback Europe’s vaccination progress even more starkly compared to the US.

The economic side-effects of which has not been lost on markets as EZ yields fell back, along with EUR slipping under mid-1.19. But pre-FOMC though moves are restrained by uncertainty.

But not all side-effects present themselves so nefariously.

The record-breaking streak on Wall St, with Dow’s sixth consecutive all-time high and S&P500’s hat trick of record, is a side-effect of exceptional monetary and fiscal stimulus; yet unnerved by rising yields. For one, UST yields have eased back on the day (10Y dipping sub-1.6% ). But crucially, suggesting markets’ faith that the Fed will keep policy sufficiently accommodative.

The finer point may be that the Fed may not aggressively pushback on optimism lift in yields whereas in contrast, the BoJ cranks up stimulus; resulting in a more buoyant USD/JPY. A side-effect of a less alarmed Fed but welcome, even if not an intended outcome, by BoJ.

Market otherwise appear to be in consolidation ahead of tomorrow’s FOMC, where the verdict on, and response to, the side-effects of rising yields from recovery hopes is assessed.

AUD consolidates mid-0.77 as RBA Minutes maintain easing bias. But side-effects of frothy home prices, AUD outperformance on commodities and UST yield volatility remain bugbears.

Clearly, side-effects from vaccines are not the only worry in these times. Especially given that some of the policy side-effects on asset prices may be addictive.

The RBA’s Thorny ChallengesThe RBA has two thorny challenges. First, the spillover of volatile UST yield surge. Second, reflation-related AUD strength; which, with the exception of “risk off” triggered by sharp upside in UST yield surge, tends to be dominate via commodity channels amid optimism about vaccine-led recovery.

And these are not fully elucidated in the Minutes.

On yield volatility, flexibly deploying current QE and YCC tools to dampen yields without pre-committing to further B/S expansion appears to be the RBA’s preferred approach. This is understandable given that the data are pointing to a fairly resilient recovery; as successful Covid containment flanked by resolute fiscal policy support (trained on jobs) have backstopped unemployment and helped with a faster turnaround in consumption.

In fact, signs of the housing market getting a tad too hot (side-effect!) a little too soon suggest that the RBA has a higher bar to expanding QE/extending YCC (out the curve).

On exchange rates, the RBA must work within uncomfortable constraints as well. Fact is, while RBA chief Lowe has openly expressed preference for a weaker AUD, he has also conceded that AUD is not overvalued.

Which is to say, the RBA has no solid grounds for intervention at current levels. That is, not without wading into “manipulation” territory.

Point being, this implicit ambivalence on AUD casts policy doubts.

The big picture is that the RBA’s thorny challenges, and front-loaded stimulus – monetary and fiscal – place constraints on a set-piece policy response at this juncture. Which means a flexible approach within the current QE-YCC regime remains optimal for now.

That being the case, RBA watchers will pore through the Minutes to confirm that indeed the RBA may opt more nimble play strategies, but not (yet) shift QE/YCC goalposts. For now, AUD is likely to tread fairly cautiously as the Minutes are digested.

RBA preference for a softer AUD may coincide with USD’s edge amid UST yield volatility to contain AUD upside.

Source: Mizuho Bank Ltd