Australia’s Macro Outlook and Monetary Policy

Australia's Macroeconomic Outlook

• NAB business survey reported business conditions at an all-time high, indicating a multi-decade peak in activity.
• Near eradication of local virus transmission and modest mobility restrictions have driven a rapid normalization of economic activity.
• GDP growth, employment levels, and consumer spending have largely returned to pre-COVID baselines.
• Key cyclical sectors, specifically the housing market, are showing strong signs of recovery.
• Goldman Sachs 2021 growth forecast for Australia is 5%, positioned at the top of market consensus.
• Recovery drivers include a large pool of excess savings, unspent fiscal stimulus, and highly accommodated monetary policy.
• Risks to the outlook include potential new COVID outbreaks, a slow vaccine rollout, and increased virus transmission during winter months.

Reserve Bank of Australia (RBA) Policy: Yield Curve Control (YCC)

• The RBA has implemented Yield Curve Control (YCC) to maintain the 3-year government bond yield fixed at 0.1%.
• The operational target is specifically the April 2024 bond, achieved with minimal volatility around the 0.10% level.
• The correlation between the targeted yield and other yields, including US bonds, has fallen significantly.
• Primary objectives of YCC include reinforcing extreme dovish forward guidance and ensuring interest rates do not rise until at least 2024.
• The policy provided critical certainty during the COVID crisis when price discovery was poor and conventional QE calibration was uncertain.
• Current tensions exist between maintaining the 0.1% yield cap and forward guidance suggesting rate hikes as early as 2024.
• Goldman Sachs anticipates the RBA will exit YCC not by abruptly abandoning caps, but by ceasing to roll the target bond forward, allowing the program to decay naturally.
• A gradual unwind over several years is expected to avoid significant immediate tightening or financial market disruption.
• The RBA is expected to pair the YCC unwind announcement with a third extension of its conventional quantitative easing program, potentially in July.
• Continued dovish forward guidance will be utilized to prevent the YCC exit from being perceived as a hawkish policy pivot.

Market Reaction and Credibility

• Markets currently price approximately 40 basis points of tightening by the end of 2023, indicating YCC is not viewed as 100% credible by the interbank cash market.
• Despite market pricing, Goldman Sachs views the policy as having a useful impact, noting that US markets are pricing a more hawkish trajectory than Australia on this timeframe.
• In a counterfactual scenario without YCC, markets would likely price even more tightening than currently observed.
• The RBA's base case remains that interest rates will not be hiked until toward the end of 2024.
• The RBA is positioned as the first modern precedent for exiting YCC, with the success of the exit phase remaining the most critical unknown.
• Risks include the potential for a sudden abandonment of yield caps if the macro recovery is misread, which could disrupt markets and damage central bank credibility.
• YCC is not a perfect substitute for conventional quantitative easing regarding lowering the broader term structure of rates or influencing currency values.

Sector Implications: Housing Market

• The dovish policy stance supports risky assets, with a central scenario projecting a 20% rise in Australian house prices over the next two years.
• Housing reflation is expected to drive the broader economic recovery through positive wealth effects and a boost to the construction cycle.
• Government intervention or macroprudential regulation to curb housing affordability is considered a low risk in the near term.
• Australia is distinguished from New Zealand by a different political approach to housing affordability and a less advanced phase of the reflation cycle.
• Australian lending standards remain robust due to long-term regulatory focus, reducing immediate regulatory intervention risks.
• Macroprudential regulation is identified as a key area to monitor over the medium term, though unlikely to impede strong reflation this year.