Unconventional policy will likely arrive in Australia in 2020.

RBA Governor Lowe has detailed his preference for a possible RBA Quantitative Easing (QE) program after further RBA rates cuts. Lowe suggests “if’” the RBA was to undertake such a program of QE, it would target “risk-free assets of Government Bonds by buying these securities in the secondary market”, as such a program of lowering risk-free asset yields seeps into all parts of the economy.

Whilst the RBA maintains a mildly constructive outlook for the Australian economy in the near term, sadly its recent forecasting history has been poor. We do not share this optimism looking forward into 2020. This time last year the RBA was forecasting ‘’the stance of monetary policy (then current as at December 2018) would continue to support economic growth and allow for further gradual progress to be made in reducing the unemployment rate” and this standout, “the next move in the cash rate was more likely to be an increase than a decrease”.  The RBA followed this forecast by cutting the cash rate three times shortly thereafter.  We believe the economy remains vulnerable to a further slowdown in the South East Asian region which has suffered one of the worst macroeconomic years on recent record. JCB’s core view remains that the U.S./China trade war remains firmly “on”, but we may get some window dressing phase 1 type deal which will be form over substance and unlikely to spur material macro acceleration beyond a few days of positive market reaction.

There isn’t a consistent playbook around QE but looking at other global QE programs does help suggest decent scenarios for Australia into 2020 and beyond.

The RBA is correct to point out that Australia has lots of positives including positive growth, positive demographics, lower currency, fiscal firepower, etc, but now that Lowe has given the Australian market its famous “put” moment, market participants will be screaming for more stimulus at the first bumps in the road.

Optimism reaches fever pitch in some markets, but sadly the secular environment doesn’t move that fast as some green shoots are turning brown.

Looking at equity and property markets of late you would naturally think that the economy is booming, and life is pretty grand for average folks in the economy. Sadly that is not the case, as the macro environment remains tepid. Pessimism overshot to an extreme level into September with yield curve inversion and ‘recession’ searches on Google reaching peak readings. The argument for a turnaround in the economy was built on shallow ground as the receding of Brexit risks and thawing of trade war negotiations has provided hope that the economic slowdown is close to a bottom. Unfortunately for the green shoots to flourish we will need more substance from our dynamic political leaders in resolving trade wars, Brexit and fiscal expansion rather than the ‘kicking the can down the road’ mentality that is currently evident.

We believe that the markets have run hard looking for underlying improvement that is difficult to deliver without deleveraging and undertaking material structural reforms – both broadly missing in this economic cycle. No doubt a material and complete trade deal between the U.S. and China dealing with technology and Intellectual Property could spur some animal spirits, however, the best macroeconomic investors can hope for seems to be a mild acceleration in the economy. One caveat to this outlook remains massive fiscal support, although those programs take significant time to deliver.  The secular environment remains that of highly-indebted, low-productivity economies with aging populations, which will continue to drag on economic outcomes.  

The December 15th date for additional tariffs on China will likely be a binary moment for markets into Christmas and year end illiquidity.

Viewing from afar the playbook for U.S./China trade deal negotiations seems to be something like the following:

Constructive talks are held between both parties, some progress is made, and feel good factors run high in both camps. Trump then announces the ‘’deal’’ and pumps the markets repeatedly, turning to twitter and other media outlets constantly repeating his amazing victory, whilst also sending his army of media mouthpieces onto CNBC, Bloomberg and Fox news hammering similar positive messages. In doing so the U.S. position is somewhat cornered.  

Knowing this, at the 11th hour China seems to ask for ‘’just a little extra’’ and the entire outcome collapses.  This happened in May when China backed away from changing domestic laws around enforcement functions and seems to be happening again on a ‘’phase 1’’ deal as China wants current tariffs rolled back, and future tariffs slated for December 15th avoided.  It is very difficult to forecast how this will play out in the near term, other than to suggest we have volatility ahead around a binary outcome mid-month. We continue to believe that the entire process is governed by a ‘’no pain no progress’’ mentality from Trump’s side, and whilst U.S. equity markets remain high, the U.S. Federal Reserve is standing ready to support the weakening economy and Trump approval ratings are elevated, it is unlikely that material concessions will be made on the U.S. side. Trump is behaving increasingly erratic as impeachment process continues to build, and Trump may well need an enemy to fight against on behalf of the people come November 2020 elections. It looks like 2020 will continue to be dominated by further trade issues and tariffs.