Reserve Bank of Australia – Uncharted territory for unattainable goals

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Reserve Bank of Australia – Uncharted territory for unattainable goals

3 October 2019

 

 

Aidan Shevlin, CFA
Head of Asia Pacific Liquidity Fund Management
J.P. Morgan Asset Management

 

 

At the beginning of October, the Reserve Bank of Australia (RBA) cut its overnight cash rate by 25bps to a new record low (Exhibit 1a).  The third rate cut in five months has effectively halved the central bank’s key policy rate – leaving the RBA in uncharted territory and one step closer to unconventional monetary policy to achieve potentially unattainable employment and inflation goals.  The current trajectory of cash rates will have significant and far-reaching implications for local currency cash investors.

Optimistic rate cuts

In recent speeches, RBA governor Philip Lowe struck an upbeat tone, noting the economy had reached a “gentle turning point”1 helped by a combination of low interest rates, tax cuts, lower currency, infrastructure spending and housing market stabilization.

Despite this professed optimism, the RBA still cut rates in October and remained dovish, committed to “ease monetary further if need to support sustainable growth in the economy, full employment and the achievement of the inflation target”2. However, given current lack of macroeconomic drivers to achieve the central banks full inflation of 4.5% was last reached in 2008 and core inflation target of ≥2% (Exhibit 1b), the probability of attaining either goal remains remote.

The reality is more nuanced: While Australia is currently in its 28th year of economic expansion, gross domestic product (GDP) growth has slowed to a decade low; moreover the rising participation rate is offsetting almost 2-years of positive jobs creation and despite the recent recovery, housing prices have fallen below their long-term trend.  Meanwhile, the long term slowdown and rebalancing of the Chinese economy will eventually weigh on exports – although short-term Chinese infrastructure stimulus will benefit Australia’s commodity driven economy.

Sluggish consumption and structural trends

Apart from weak global growth, the RBA’s other key domestic concern remains the lack of growth in domestic consumption – especially during a period of rising employment.  However, this can partly be explained by job insecurity, muted wage growth and the high level of consumer indebtedness (Exhibit 2a).  All these factors should still benefit from lower interest rates – suggesting that monetary policy remains an effective policy tool – provided commercial banks pass the rate reductions on to consumers.

Interestingly, for the first time, the RBA alluded to a new rationale for the latest rate cut.  The structural shifts in global interest rates (Exhibit 2b) – which have fallen to record lows have also placed downward pressure on Australian interest rates.  The central bank fears if it ignored the actions of major central banks, the “exchange rate would appreciate, which in the current environment would be unhelpful on terms of achieving both the inflation target and full employment”3. 

The implications of sustain lower interest rates

The recent rate cuts, fiscal stimulus and continued Chinese commodities demand, suggest the modest Australian economic recovery is likely to endure.  However, growing expectations of additional monetary policy easing by major central banks may force additional, unnecessary RBA rate cuts and even trigger unconventional monetary policy to restrain unwanted capital inflows and AUD appreciation.

For Australian cash investors who are more familiar with high interest rates, steep yield curves and competitive deposit rates, the prospect of extremely low or even zero yields represents a significant challenge.  These difficulties have been compounded by the Royal Commissions impact on commercial banks demand for deposits and the Australian Prudential Regulatory Authority’s (APRA) clarification on the definition of cash.

Nevertheless there are several techniques developed and refined during the past decade of zero US interest rates which should help Australian corporate treasurers mitigate some of these complications.  These include diversifying beyond deposits into money market funds and ultra-short duration funds,   segmenting cash by liquidity requirements and identifying sectors and tenors that offer additional return for minimal reductions in liquidity and security. 

Although combining these three techniques will not fully offset the negative impact of RBA rate cuts on cash returns, they will allow treasurers to achieve a competitive return consistent with the objectives of capital preservation and maintaining a high degree of liquidity.

To read more our liquidity insights, visit www.jpmgloballiquidity.com

 1 An Economic Update by Philip Lowe; as of September 24, 2019

2 Statement by Philip Lowe, Governor: Monetary Policy Decision; as of October 1, 2019

3 An Economic Update by Philip Lowe; as of September  24, 2019

IBOR Fallbacks: 7 Questions Corporate Treasurers should ask

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Anyone who’s been reading the financial press knows that LIBOR is on the nose. Billions of dollars in fines, sanctions, regulatory action and even jail time have ensured LIBOR has a limited life.

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LIQUIDITY INSIGHTS: DEFINING CASH FOR AUSTRALIAN INVESTORS

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Defining cash for Australian investors

Aidan Shevlin, CFA
Head of Asia Pacific Liquidity Fund Management
J.P. Morgan Asset Management

The definition of cash, while ostensibly straightforward – banknotes and coins – becomes increasingly challenging when the demands for higher returns counteracts the obligation to ensure adequate liquidity and the commitment to avoid losses.

As memories of the liquidity stress and market dislocation triggered by the global financial crisis faded, the range of financial instruments deemed acceptable in Australian cash products broadened dramatically. This was also a time when investors grappled with the challenges of outperforming attractive headline retail bank deposit rates.

Unfortunately, defining which instruments are truly cash equivalents is one of the most difficult tasks for modern corporate treasurers.

The Regulatory Dilemma

Globally, cash investors look to regulators and rating agencies to define and clarify suitable cash investment instruments and structures.  This is especially true in the United States, European Union, and China, where the size and systemic importance of liquidity and money market funds (MMFs) made this a critical regulatory issue following the 2008 financial crisis.

These rules and regulations vary from prescriptive, listing specific approved and unapproved instruments, to abstract, outlining key sources of investment risk and limits to mitigate them.  Regardless of the regulator’s philosophy, the ultimate goals remain the same – to ensure adequate liquidity and minimise the probability of losses.  Over the past decade, global regulators have strengthened MMF guidelines. They now demand higher levels of liquidity, impose tighter investment limits and require increased diversification.  For both retail and institutional investors, these new rules have raised the standard of MMF investing while significantly reduced the likelihood of funds suffering losses, albeit at the expense of lower potential returns.

In contrast to detailed global standards, Australian regulators have historically demurred the responsibility to define cash or the suitability of various instruments for cash investments.  The Federal government’s unlimited bank guarantee during the Global Financial Crisis helped shelter the local financial industry while a long history of self-regulation encouraged investors to create their own definitions of cash and cash equivalents.

However, in 2018, a review of cash investment products by the Australian Prudential Regulation Authority (APRA) raised significant concerns about the level of volatility and risk in these products.  Across the industry, the range of instruments and structures defined as cash varied enormously – as did returns. This created confusion for retail and institutional investors.  In its subsequent report, APRA highlighted “examples in the industry where cash investment options appear to include exposure to underlying investments that would not generally be considered cash or cash-like in nature”1.

To encourage investment consistency and reduce the volatility of cash investment products, APRA concluded that “cash equivalents represent short-term, highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value”1. 

Cash means security, liquidity and return

The report signalled a tougher regulatory stance and additional focus on questionable cash investments styles.  However, in the absence of detailed regulatory guidelines and exact definition of liquidity and risk, investor due diligence is still required to balance the need to preserving capital, while ensuring suitable levels of liquidity and maximising returns.

Three key steps in this process involve clarifying investment policies, creating well defined investment objectives and implementing cash segmentation.

Firstly, using an investment policy statement forms a solid foundation for cash investment decisions.  A well written policy provides clarity, instils discipline and allows the organisation to successfully navigate shifting markets, changing regulations and evolving business needs.

Secondly, by defining short term investment objectives and the strategies for achieving them, an organisation can establish acceptable levels of risk, identify permissible investments and detail relevant constraints.

Finally, by putting cash into different segments, the organisation can optimise its investment choices – ensuring it has sufficient liquid cash to meet its daily needs while avoiding the opportunity costs associated with very high levels of liquidity and principal protection by diversifying across different types of cash investment depending on their level of liquidity, volatility, and diversification.

In Conclusion

The new APRA definition of cash has already prompted a significant reorganisation across the Australian cash management industry with several instrument structures being avoided and more conservative investment guidelines introduced.  This, combined with more due diligence and understanding of the underlying risks by retail and institutional investors, should help the industry create a safer foundation for future growth.

To read more our liquidity insights, visit www.jpmgloballiquidity.com

  1. CASH INVESTMENT OPTIONS’ NON-CASH HOLDINGS: INDUSTRY GUIDANCE

Agile Treasury Thought Leadership Series – Empower and Scale

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Agile Treasury Thought Leadership Series – Empower and Scale

Systems should empower people to effectively perform clearly defined processes, which means that time spent innovating and making valuable strategic decisions is maximised.

Designing a system can only be best achieved once the process the system is meant to empower is first designed. Ideally, the process will also be developed, implemented and operated for a period in a fast, flexible solution (Excel!) to refine the steps, calculations and clear actionable outputs.

Common Shortfalls

• Expensive, committed technology licenses
• Highly fragmented system data and multiple sources of truth
• Lack of process planning prior to technology commitment
• Extended implementation and training
• Lack of technology flexibility as strategic requirements change
• Lack of dataflow alignment to processes and policies
• Lack of prescriptive or clear calls to action from workflow output

Solutions
• RFP management should an advanced system still be deemed valuable
• Strategic and holistic construction of low-cost, flexible operating tools in Excel
• Implementation and training on new system
• Integrated solutions for the identification, measurement, management and monitoring of risks

Download a copy of the case study prepared by Rochford Group on a global pharmaceutical distributor.

Download case study

This case study has been developed by Rochford Group

Rethinking Treasury by HSBC

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How CFOs and corporate treasurers are rising to the risk management challenge

The HSBC Risk Management Survey findings highlight a number of themes that are likely to reshape and strengthen the relationship between the CFO and treasurer in the future.

  1. CFOs expect their treasurer to react to more risks in a faster and more efficient way
  2. Treasurers need to view the world through an increasingly strategic lens.
  3. Rethinking the role of the treasury is likely linked to further digital transformation.
Download the findings

Get ready for the global IBOR transition

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Get ready for the global IBOR transition

Have you met SONIA? Financial institutions are beginning to plan for the transition away from traditional IBORs, a change described as one of the biggest to ever occur to financial markets.

In December last year, Commonwealth Bank of Australia (“CBA”) did something that no other Australian bank had done before. It issued an Australian-origin transaction with a reference rate that was not an interbank offered rate (“IBOR”). The CBA transaction (GBP125 million of one year notes) referenced a margin of 40 basis points over the Sterling Overnight Index Average (“SONIA”), the interest rate benchmark being primed to take over from the London Inter-bank Offered Rate (“LIBOR”).

Download a copy of the full Treasury Trends article by Barrington Treasury Services.

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This piece has been developed by Barrington Treasury Services.

The Women in Treasury Global Study 2019

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The Women in Treasury Global Study 2019

Treasury Today’s global Women in Treasury initiative recognises the importance of women in the corporate treasury profession and creates a means for women in treasury to communicate with one another; learn from each other and network in order to help each other. Whilst the treasury profession remains largely male-dominated, there are remarkable women enjoying remarkable careers.

Women need to be much more visible in their roles, both inside and outside of their organisation. While women can hesitate to promote themselves, this initiative aims to help bridge the gap.

Treasury Today run an annual global study of women working in the treasury profession to build up a picture of the profiles and careers of women from junior roles to Group Treasurer/Financial Director/CFO positions. The study is now open and we strongly encourage you to participate and make a difference!

Take the survey

Exchange April 2019

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The April Exchange Newsletter is out now! The newsletter covers upcoming CPD events including the Treasury Management Course and Fundamentals, and more!

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Agile Treasury Thought Leadership Series

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Agile Treasury Thought Leadership Series


People should be empowered to innovate and perform critical decision making, which means they are driving long-term strategies that maximise enterprise value.

Any agile treasury process needs to be designed from a holistic stakeholder perspective. This means lateral input across a senior level, but also, critically, horizontal input from key operational staff through to the CFO and the Board. This is especially true for global entities with staff in diverse time zones or who maintain relatively low interaction with head office.

Common Shortfalls
– Lack of time
– Skills or experience gap
– Competing or uncertain strategic agendas
– Team size limitations
– Excessive key-man risk
– Lack of KPI alignment to commercial & risk management objectives

Solutions
– Consultation with stakeholders
– Ongoing experienced strategic and operational support
– Event driven strategic advice and management
– Upskilling internal personnel
– Align individual’s performance assessment/awards to relevant KPIs

Download a copy of the case study prepared by Rochford Group on how they identified, designed and implemented an interim and long-term solution for a client.

Download case study

This case study has been developed by Rochford Group

EACT Briefing Focus: KYC

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EACT Briefing Focus: KYC

KYC has become a serious concern for many corporate treasurers over recent years: it is increasingly complex to fulfill all unstructured requests. In all recent surveys conducted by the EACT, KYC is listed as a top priority for corporates and its rising costs are a source of frustration as KYC consumes lots of time, resources and money. Central KYC registers or solutions would create significant savings.

Download the report