The Seinfeld election

Delivered on By Justin Pyvis

Good morning! It may be election season but has anyone noticed the glaring lack of anything resembling policy from either side of the political divide? The AFR’s John Kehoe certainly has:

“In the view of business leaders, this is the Seinfeld election. It’s a show about almost nothing, at least in terms of major economic policy substance.”

Seems accurate. Productivity and reform must be naughty words inside governments around Australia (state and federal) these days. Just keep up the deficit spending and someone else can worry about how to repay it all as the economy slows, the resources boom dries up and interest rates rise.

Australia Decides 2022: The election about nothing.
Australia Decides 2022: The election about nothing. Source

Reading the tea leaves

Daily % change

AUD/USD

74.2

-0.5%

AUD/CNY

4.72

-0.4%

AU Bond

3.01

+0.7%

US Bond

2.78

+2.5%

ASX200

7,485

+0.1%

S&P500

4,413

-1.7%

Brent (bbl)

99.0

-3.7%

Gold (oz)

1,958

+0.8%

Iron ore (t)

151.4

-2.4%

Bitcoin

39,810

-5.7%

Ethereum

2,994

-6.8%

Note: Brent oil, gold bullion and iron ore prices are the second futures contract. Bond yields are 10-year Treasuries.

TheΒ US S&P500Β fell -1.69% in a broad-based selloff ahead of tonight’s March inflation data, with all 11 sectors in the red led by energy (-3.1%) and tech (-2.6%).

Earlier in the day a Reuters poll found that economists expect the Fed to deliver two back-to-back 50 basis point interest rate hikes in May and June, with the odds of a recession now up to 40% next year. Meanwhile, consumer expectations of where inflation will be in one year rose to 6.6% in March, the highest since the survey was launched in 2013.

Locally, theΒ ASX200 eked out a small 0.1% gain on what was a mixed bag of a day, with 6 of the 11 sectors losing ground. The standouts were financials (+0.78%), which rose along with bond yields on the expectation of higher interest rates in Australia as soon as June (see Food for thought below for plenty more on that).


Food for thought

If yields don't fall, the RBA could incur losses on its bond holdings for potentially the next decade.
If yields don't fall, the RBA could incur losses on its bond holdings for potentially the next decade. Source

The yield on 10-year Australian government bonds topped 3.0% for the first time since July 2015 yesterday, as the odds of a June rate hike grow stronger.

Bond yields move inversely to price, with the start of a global tightening cycle causing investors to dump government debt at a rate never seen before – bonds have lost ground for eight consecutive months, officially the longest losing streak on record.

That spells trouble for the Reserve Bank of Australia (RBA), which loaded up on around $A350 billion worth of Australian government debt as part of its pandemic ‘quantitative easing’ (QE) programme. While those purchases were spread relatively evenly across the next 10 years (see chart above), the RBA will be forced to declare significant mark-to-market losses on its holdings.

In the 2020-21 financial year, the RBA reported unrealised valuation losses of $A8.2 billion on its portfolio of financial assets, $A4.7 billion of which came from its $A232.7 billion stock of Australian government bonds.

We can’t know precisely what those losses would be today but with a 150% increase in bond yields and a 50% increase in the RBA’s bond holdings since 30 June, it’s likely already north of $A20 billion. For reference, the Betashares long-dated bond ETF is down -10.8% since 30 June, which if applied only to the RBA’s holdings at that date and not the $A123 billion it subsequently purchased, would equate to a loss of $A25 billion.

That’s significant – unlike its peers in countries such as New Zealand, the RBA did not seek indemnity from Treasury before embarking on QE. While the RBA plans to hold its stock of bonds until they mature, limiting its eventual losses, it will still lose something: many – if not all – of the bonds purchased had a coupon well above the market rate at the time, meaning it had to pay a premium over the face value at which the bonds will mature.

To highlight just a single example, the RBA purchased $A2.8 billion of November 2028 government bonds yielding 2.75% in January 2021, when the market rate for that bond was just 0.79%, implying a premium of around 11.5% (there are plenty of bond price calculators floating around, give it a try). If the RBA holds those bonds until maturity it will record a loss of around $A320 million in November 2028. If it sold them today it would lose that plus an additional $A20 million, given that the yield on those bonds is now 2.9%.

Those very real losses will start to hit the RBA next financial year as the first tranche of QE bonds mature, limiting its ability to pay what is normally a multi-billion dollar dividend to the government (assuming that bond yields don’t plummet, of course). The RBA will also need to seek permission from the government to alter its capital adequacy framework yet again this year to allow it to ignore its unrealised bond losses, or ask Treasury for a large recapitalisation.

Finally, the RBA’s experiment also means so-called quantitative tightening – the opposite of QE, where asset and consumer price growth is slowed by selling bonds to raise longer-term yields – will be virtually impossible in Australia without the RBA realising significant losses, potentially creating a bias towards easier monetary policy.

All in all, not a good look for an institution staffed by 1,380 well-paid bureaucrats that’s long overdue an independent inquiry into its operations.


Chewing the fat


Bits and bytes

πŸ™Š Where’s his cheat sheet? “Anthony Albanese has stumbled on the first day of the election campaign, unable to recall key economic figures [the cash rate + unemployment rate] while trying to spruik Labor’s credentials for government.”

πŸ“ˆ Consumer and producer prices in China increased by more than expected in March, rising 1.5% and 8.3% respectively. Higher inflation may limit the central bank’s ability to offset China’s rolling lockdowns.

πŸ‰ The lockdown in Shanghai was described as “barely controlled chaos as everyone locked into apartment bldgs and looking for food via group chat for gov’t to deliver. Sometimes you get it, usually you don’t. Plain watermelons going for $100 each”.

πŸ—οΈ Perth-based Home Innovation Builders and New Sensation Homes are the latest Australian construction companies to fall victim to inflation, appointing liquidators as soaring material and labour costs erode their narrow margins.

πŸ“‰ The World Bank expects Ukraine’s economy to contract by 45.1% this year, “as Russia’s invasion has shuttered businesses, slashed exports and rendered economic activity impossible in large swaths of the country”.

❌ Elon Musk turned down the offer to join Twitter’s board, meaning he will have no direct influence on the company but will also have no obligation to act in the best interests of shareholders (he owns 9.2%).

🏒 Guess they’re all still working from home: Elon Musk suggested using the Twitter HQ in San Francisco as a “homeless shelter since no one shows up anyway”.

πŸ—³οΈ In a rematch of the 2017 election, France’s President Emmanuel Macron will face Marine Le Pen in a runoff scheduled for 24 April. The “two former two main parties - the Socialists and Les RΓ©publicains - picked up under 7% between them”.

πŸ›’οΈ US President Joe Biden met with India’s Prime Minister Narendra Modi to discourage a “rapid acceleration” in the latter’s imports of Russian oil. However, the US will not will not set any “red line” limit.

🚘 Passenger vehicle sales in China fell -10.9% from a year ago in March as lockdowns sapped demand and restricted supply (Shanghai is a major producer). New-energy vehicles sales jumped 137.6% to 445,000 (27.6% of total sales).

πŸ¦— Andrew McDonald is set to be the Australian men’s cricket team’s new head coach, with the decision to be announced within the next 48 hours.