This year, there has already been a sharp drop in bond yields, the 10-year rate plunging from 47% to its current level.
The decline is due to changing expectations regarding the economic outlook, said Westpac’s pricing strategy chief Damien McColough. “We had the triple blow of the bushfire drought in Covid-19.”
Yields could fall further in the event of a recession, he said. “It should absolutely be argued that yields could drop 50 basis points by the time of a recession, easily. At some point, they bounce back considerably, but that would be two years later.”
Against mounting fears over damage to the economy caused by coronavirus, the Reserve Bank cut rates at its March meeting on Tuesday, reducing the cash rate by 25 basis points to a record low of 0.5%.
Bank of Canada
The Reserve Bank was the first central bank to cut this week, but others quickly followed suit, with the US Federal Reserve and the Bank of Canada cutting official rates by 50 basis points.
Central banks fear that the rapid spread of coronaviruses from China to the rest of the world is a serious obstacle to global economic growth.
There is a history of global economic shocks that fail on the Australian coast, as did the global financial crisis of 2008.
“Global shocks have always been significant, as we have seen in the GFC,” said Commonwealth Bank chief economist Michael Blythe. “In the GFC, we were fortunate to avoid the recession.”
Australia has avoided economic contraction through a combination of cash discounts and other government measures undermined by the resource super-cycle. The government has announced a new multi-billion dollar plan to support the economy, which is expected to be announced next week.
Market economists support the proposed tax measures with the sole reservation that this might not be enough.
“You need something that represents a reasonable share of GDP and $ 4 billion is probably the minimum you are looking for,” said Blythe.
“It is as much a shock of confidence as anything else and for policy makers to do something is probably very important,” he added.
Alan Oster, chief economist at the National Australia Bank, went further. “I want a lot. I don’t want $ 2-3 billion. I think it should be $ 10-15 billion.”
“I would like the money to go to households and small and medium-sized businesses. Anything you can do for maintenance and infrastructure would also help, but it has to be spent in the next six months. I think we have probably need a serious tax cut, “he added.
Plank at ANZ said $ 4 billion to $ 5 billion would be a reasonable amount of fiscal stimulus if implemented in the second quarter of the year. “It has to be delivered quickly,” said the economist. “They really need to deliver it now.”
The economist added that “the yields on 10-year government bonds are already at 0.8%. Perhaps they will reach 0.5% if we proceed with a quantitative easing”.
As expectations rise for a budgetary response, the markets are also seeking more interest rate cuts from the Reserve Bank and, potentially, an unconventional policy.
Last year, the Reserve Bank reported that quantitative easing would be possible if interest rates fell to 0.25%.
“I think 0.25% interest rates and quantitative easing are much more likely now,” said Shane Oliver, chief economist at AMP Capital.
The conditions necessary for the 10-year bond yield to reach 0.25% in the coming months would be a mixture of lingering concerns about the coronavirus, greater monetary easing worldwide and another decline by the Reserve Bank at the time. as markets anticipate QE, Dr. Oliver told me. “The likely boost for bond yields is probably weaker.”
The QE overlay “brings more questions than answers” to the bond market, said McCacough of Westpac.