I have repeatedly warned that with further RBA rate cuts likely to come (the futures market is pricing in a 0.4 per cent cash rate by end-2020), it is probable that the realised capital gains will be closer to the top end of our heterodox forecast range.

And there is little doubt that sluggish mainstream analysts will start falling into line with these projections.

Before I get reflexively stereotyped as a housing bull, remember this column correctly predicted the 10 per cent decline in national prices in April 2017 while values were still ascending (most analysts followed us 12 months later, although many got overexcited, calling for a 20 per cent crash).

There is probably only one CEO I really trust to pull this off: ANZ’s Shayne Elliott.

This is wonderful news for the economy at a time when global uncertainty is elevated. Australia is truly the “wonder Down Under”: we’ve had 28 years of growth, the return of a balanced federal budget, the prospect of a rare current account surplus, an orderly deflation in our dangerous housing bubble, low borrowing rates and an increasingly competitive Aussie dollar.

From an investment perspective, the biggest beneficiary of this development is the residential mortgage-backed securities (RMBS) market and our banks and non-banks more generally. (RMBS is a bond comprising a pool of home loans.) The creditworthiness of RMBS is determined by borrowers’ ability to repay the loans coupled with the value of the underlying properties that serve as collateral.

Recent declines in mortgage rates should reduce default rates while rising house prices boost the equity protecting these bonds. So after we controversially exited the RMBS sector when house prices started falling, we have been buying these securities again in anticipation of their improved prospects.

A final positive for the sector is Westpac’s comfortable victory in the Federal Court in relation to the nebulous responsible lending laws, which mitigate regulatory and class action litigation risk.


While the economic portents are promising, the RBA still has heavy lifting to do if it is to fulfil its legislated objectives of delivering inflation between 2 and 3 per cent and full employment.

Even assuming another two rate cuts, the RBA’s forecasts have the jobless rate sitting at 5 per cent in 2021, which is materially above its estimate of the “fully employed” jobless rate between 4.0 and 4.5 per cent. It also has core inflation right at the bottom of its 2 to 3 per cent target band.

Dollar complication

Put more bluntly, pushing the RBA’s official cash rate down from 1 per cent to 0.5 per cent will not – according to its own analysis – allow it to satisfy its mandated employment and inflation objectives. And if global central banks continue to slash their interest rates, as the US Federal Reserve and European Central Bank are expected to do in September, the RBA’s task could be complicated by upward pressure on the Aussie dollar.

During the week, the RBA’s impressive deputy governor Guy Debelle explained that Martin Place has invested a great deal of thought into the additional tools it could deploy to help manage the economy once it hits the effective lower bound on its official cash rate, which he acknowledged was around 0.5 per cent (below this the RBA does not expect much, if any, pass-through from banks).

He was, in fact, echoing the thoughtful remarks of his governor, Phil Lowe: both have now confirmed this column’s May 2019 prediction that they will embrace so-called quantitative easing (QE) if they have to cut rates another couple of times.

Financial market participants love using jargon to make themselves sound smart. Yet QE is really just an extension of the RBA’s existing monetary policy framework that will enable it to influence a broader and longer-dated range of interest rates.


Historically, the RBA has focused on its overnight cash rate, but this is not the sole determinant of borrowing costs. Two other key variables are longer-term risk-free rates, as proxied by yields on government bonds, and the premium above the risk-free rate banks borrow at to serve as intermediaries funnelling savings into loans.

When during the global financial crisis (GFC) the RBA slashed its cash rate, the monetary policy transmission mechanism was complicated by the fact that bank funding costs (aka credit spreads) spiked.

Banks should embrace automation

While today liquidity is plentiful and corporate credit spreads have reverted back to pre-crisis levels, the spreads on bank bonds remain up to eight times wider than they were in 2007, despite banks having more than halved their risk-weighted leverage.

There is probably only one chief executive I really trust to pull this off: ANZ’s Shayne Elliott. Fairfax Media

A five-year senior bond that cost a major bank 10 basis points above the bank bill swap rate in 2007 now trades on a spread closer to 80 basis points. This is important because our banks rely much more heavily on bonds to fund themselves than competitors overseas.

By buying government bonds, the RBA can compress long-term risk-free rates, which could help keep Australia’s exchange rate competitive given the latter is meant to theoretically price off global interest rate differentials.

But this will have little impact on local savings and loan rates. To influence these, the RBA will have to ameliorate bank funding costs and then insist these savings are passed on to borrowers.

Since 2015 this column has argued that the banks’ 18 per cent-plus returns on equity would converge towards their cost of equity as they deleveraged their balance sheets and reduced business model risks. This story has played out and transferred wealth from shareholders to bank creditors. Headwinds for equity remain in the form of huge regulatory imposts, modest revenue growth and intense competition from non-banks and foreign banks.

The one lever banks have to boost returns is slashing their massively inflated human cost structures, which account for about 60 per cent of operating expenses. And there is probably only one chief executive I really trust to pull this off: ANZ’s Shayne Elliott. The banks need to disappear their workforces and branches, and transform themselves into automated technology companies. As Elliott cuts costs to the bone, he needs to slice straight through it – the banks are so complacent and flabby they frankly have no idea where the real minimum cost structure lies. There is only one way to find out …

The author is a portfolio manager with Coolabah Capital Investments, which invests in fixed-income securities including those discussed by this column. This column provides general information only and is not intended to provide financial advice.