Ying Yi Ann Cheng, Portfolio Manager of the Switzer Higher Yield Fund appeared on Switzer TV to discuss the current state of play on interest rates with quantitative easing and the impact it will have.
Peter Switzer (PS): Joining me now is the Portfolio Manager at Coolabah Capital and my Switzer Higher Yield Fund, Ying Yi Ann Cheng. It’s great to see you, Ying Yi.
Ying Yi Ann Cheng (YYAC): Thanks Peter.
PS: We always have a chat about where interest rates are going. We’ve seen this week the Reserve Bank basically sticking to its story that the interest rates will rise to 2024. On Wednesday came the economic growth number and the March quarter came in at 1.8% bigger than was initially expected. I think 1.1% was a guess some time ago. It looks like we’re annualized at 7.2%. Do you think this might eventually force the Reserve Bank to move early on interest rates?
YYAC: Well, firstly, the key thing is whether they will taper. In terms of moving interest rates, they’re currently enjoying quantitative easing at the moment, which includes the purchase of government bonds. They’re essentially purchasing the debt issued by the state governments and the Commonwealth Government. Before, they lift interest rates, they would need to unwind other policy stimulus that they have going on at the moment. Now, we have the term funding facility which is due to end in June.
Meanwhile, as I said they’re already doing quantitative easing. That’s purchasing the debt of the Commonwealth Government and the state governments. Before they look to lift interest rates, they would probably wind back on that. Just by the way, for your audience, the term funding facility currently allows the banks to borrow off the RBA at 0.1%, which is not being extended. The banks are awash with liquidity, deposit growth is still very strong.
So, by not extending that term funding facility, the RBA is defacto, tapering, which means that it’s not creating the same degree of easing, which it was during beforehand. If anything, our expectation is that the RBA will also continue to do QE. We think that they continue with rounded QE, as long as the economy requires, which is our base case. In terms of interest rate hikes, I think that will be some time away. In terms of tapering on quantitative easing, that could come in a couple of years – could come in the next year, but it very much depends on economic growth and other indicators.
The key for the RBA as we’ve spoken about in the past, all comes down to inflation and unemployment. Some things that we need in order to create inflation, for example, because inflation is not very high, other than the fact that we’ve had some rebasing effects, coming out of COVID – in order to generate core inflation, we really need to also wage inflation. That’s been quite anaemic.
As you know, it’s still circa around, under 1.5%. In order to get it back up, we need unemployment to fall to probably low 4%. So somewhere around 3.5 to 4%. That’s its objective. Until then, I think we will continue to see stimulus via quantitative easing by government bond purchases from the RBA.
PS: So, the summary is the central bank is so worried about the strength of the economy that they start pulling QE, you’re not going to start worrying about rising interest rates. Is that a fair point?
YYAC: That’s right. If anything, rising interest rates, I think we are about to see, and I think we’ve already seen it to a certain extent, this defacto tightening, or lift in interest rates already from the banks not being able to access the term funding facility, as at 0.1% after June. So, up until the end of the month, the banks can borrow off the RBA at 0.1%, and then they can, provide mortgages for example, to households or businesses, in terms of business lending. When they stopped borrowing off the RBA at 0.1%, they’re going to be forced to fund at wholesale levels. Trust me, that will not be at 0.1%. That will be higher. Therefore, when they borrow at higher rates in the wholesale funding market, they have to pass on that high cost of borrowing, when they lend out to households and businesses.
PS: Ying Yi, because you hang out with a bunch of fun entertaining guys and girls, who love the exciting area called the bond market, and of course you work with the most exciting person in the country, Christopher Joye – one of your debates must be around, will the inflation that’s coming through be temporary or transitory, or could it be here longer than the experts are predicting? Now, I’m sure you’ve had a debate on this around the lunchroom table, what are you guys saying about this? Do you believe that inflation is going to be temporary, and how long will temporary be?
YYAC: I think inflation is definitely a concern down the track. As we’ve seen from how concerned central banks are, especially the European Central Bank, are obsessed with inflation. That’s because when inflation does come, it tends to be quite sticky and could potentially be an issue. At the moment, we’re not even at that 2 to 3% target. When we get there, then yes, we expect inflation to hang about and inflation could be a massive issue down the track, but right now we’re not there yet. I think inflation is going to be a potential issue probably in the next 3 to 10 years. Right now, we need to get to that point. I think the Central Bank is much more willing to tolerate overshoots in inflation, given that we’ve undershot inflation for so long.
PS: Are you saying that sustainable inflation is probably 3 or 10 years down the track, but we might see a spike in inflation temporarily due to the ‘getting back to normal’ effect? I used an example recently, I said, if you could buy an airline ticket to New Zealand, it was cheap as chips. But now if you try and do it, because you can go to New Zealand apart from Victorians, it’s expensive because everyone wants to get it, so airlines will push the prices up. This is the normalization process, but after six more months when everyone’s flying again hopefully the prices will start to stabilize and price competition will come in and the inflation rate will fall. Is that a fair call?
YAAC: You’re talking about rebasing effects – yes definitely.
PS: But no one knows what you’re talking about when you say rebasing.
YAAC: Rebasing just means normalizes. Yes, there will be temporary sort of shocks. We saw this when we spoke last time. In the U.S., there was substantial numbers because they were looking at used cars for example, but again, having gone through that sort of a peak, people aren’t going to be buying multiple used cars on an ongoing basis, so we won’t see that.
My reference to inflation being an issue in 3 to 10 years is more around the concern that because we’re pumping so much stimulus and money into the system, people are going out and borrowing and purchasing. I think it’s going to be a potentially a cyclical problem down the track where it would affect growth negatively in 3 to 10 years’ time, but not right now.
PS: Let’s imagine the early phases of inflation maybe in 2 or 3 years’ time, how’s that going to affect your fund, positively or negatively?
YAAC: Good question, it will be neutral. If anything, there’s hopefully a positive effect because the fund that we do run, the Switzer Higher Yield Fund, which is one fund amongst our other portfolios at Coolabah, but the Switzer High Yield Fund is a 100% floating. There is no fixed-rate risk in the portfolio. Imagine having fixed your rate, which we’re not, at say at 1%. Let’s say interest rates move higher, you miss out on that move higher. You’re not getting paid if interest rates are now at 1.5, 2 or 2.5%. You’re stuck at 1% in terms of your income or the yield that you’re generating as a bond investor, right? When you’re a floating rate investor, or you’re invested in a floating rate fund, as interest rates move high, or that floating rate moves higher, you benefit from that because if rates suddenly moved from one to one half, you will get that 1.5% yield because of your floating rates, which the Switzer High Yield Fund would be. Our objective on top of that is to deliver alpha or capital gains over the top of that.
PS: Okay Ying Yi, as always great to catch up, but you must promise us when you and Chris start to worry you’ll get on the blower and we’ll interview you straight away.
YAAC: You will definitely hear from us.
PS: Thanks very much.
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