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Interest Rates Lower for Longer

06 November 2020

Precious Metals Commentary

A contested US election, who would have thought? Gold flip flopped between $1,880 and $1,915 to the early election headlines but last night it popped $50 as the US dollar weakened and markets considered the possibility of a policy gridlock with a Democratic President but a Republican Senate.
us gold price chart
While gold is currently consolidating just under $1,950, since the move was mostly US dollar driven the Australian dollar also strengthened, up 2.5 cents since the start of this week. The result is barely any move in local gold prices, which are still around $2,675 and continuing the sideways move that has been in play since August.

Markets shrugged off the lack of a “blue wave” of Biden spending and instead have interpreted a gridlock situation as positive as a Republican Senate would prevent tighter regulations and corporate tax hikes. Markets reacted with a strong bullish momentum and NASDAQ, S&P 500 and Dow Jones showed gains over 5%.

A new economic stimulus bill to deal with COVID’s impact on the economy will happen with Senate Majority Leader Mitch McConnell saying it was his top priority, however a divided Congress means it is likely to be a smaller than expected. That news should have been negative but markets just saw it as meaning the US Federal Reserve would, again, have to step up if there is no “blue wave” of government spending.

Silver liked the US gridlock and responded more than gold, pushing the gold:silver ratio down from 80 to 77. A Biden Presidency would likely be better for silver as climate change initiatives would favour solar electricity, which has been an increasing source of silver demand.

Interest Rates - Lower for Longer

Massive liquidity injections are not just a US story, with the Bank of England announcing £150 billion in stimulus as the forecast of a deeper corona virus recession as the UK moves into a second lockdown. Holding its benchmark interest rates at an all-time low of 0.1% (and expectations for negative rates by mid to end of 2021) the British economy is looking very sluggish with the British economy forecasted to shrink by at least 11% this year.

The US Fed made no change to its interest rates but in a statement at the Federal Open Market Committee Federal Reserve yesterday Chairman Jay Powell said that US economic and unemployment activity looked weak and identified two major risks: the surge in COVID cases, which could bring the economy to a total shutdown, and the expiration of the Cares Act benefits.

The RBA, in contrast, punished savers by taking the cash rate from its already anaemic 0.25% down to 0.10%. Normally such a change in relative interest rates between the US and Australia would have weakened our exchange rate but instead it increased.
australian exchange rate chart
The interest rate move and a commitment “to purchase [Federal and State] bonds in whatever quantity is required” was a wasted bullet and particularly embarrassing for the RBA given Governor Philip Lowe said that the objective of the “lower structure of interest rates” was to “lower borrowing costs, a lower exchange rate than otherwise and higher asset prices”.

It is clear that the RBA is more focused on saving borrowers than savers. Roy Morgan reported that an estimated 751,000 mortgage holders (20.2%) were at risk of mortgage stress and that Federal Government support “as well as measures taken by banks and financial institutions to support borrowers over the last six months is not going to last forever”.
mortgage stress chart
The other factor the RBA would be looking at is the amount of interest the government pays on its debt. Ashley Owen from advisory firm Stanford Brown says that the “current $684 billion of debt costs taxpayers $22 billion per year in interest, or $61 million every day, or $2.40 per person per day”.’

However, as the chart below shows, due to Australia’s low interest rates that interest burden on the budget is low historical when compared to Government revenues or GDP.
Australian interest burden chart
As a result, we think the RBA will continue with the [interest rate] floggings until morale improves as they said that “the Board is prepared to do more if necessary”. How long before zero Aussie rates, and maybe negative? To get there one would need to remove physical cash as an escape route and so it was with interest (pun intended) that we read about the RBA “exploring” a central bank digital currency (more on that below).

RBA’s interest rate floggings are also about trying to get inflation back to their target level. That may seem likely at this time but eventually the monetary expansion the RBA and other central banks are engaging it will have an impact. The issue is whether central banks can control inflation when it hits.

We liked how Bianco Research described the consequences of government spending and central bank monetisation:

“Think of the Fed as a post and the bond market as a horse tied to that post. The horse will remain in place, tied to that post, unless spooked by inflation. The horse has the ability to rip that post from the ground and run wild. The post cannot stop a scared horse.”

At some point the bond bull market (ie falling interest rates) will end and as rates rise government, and personal, debt will become burdensome.

Aussie Digital Cash

This week the RBA announced that it was partnering with Commonwealth Bank, National Australia Bank, Perpetual and ConsenSys Software, a blockchain technology company, on a collaborative project to explore the potential use and implications of a central bank digital currency (CBDC).

At this stage is it just a proof-of-concept and focused on a wholesale (ie not for the public) CBDC to test instant payment settlements as well as the potential for programming and automation of “money”.

The difference between what we currently use as money and a CBDC is show in the diagram below, which we modified from a RBA report in September on retail CBDCs.
different types of money diagram
The key difference is that the digital money we use currently is private bank created/issued whereas a CBDC is issued by a central bank.

Other countries are looking at digital currencies, with the European Central Bank having a dedicated webpage on it that reassures “is not meant to replace cash, but rather to complement it” and “will continue to ensure that all citizens have access to euro banknotes and coins”.

The RBA is less reassuring, saying in their September report in a section titled “Would cash be withdrawn?” that while “there may be resilience and accessibility benefits from retaining physical cash”, “it would be costly for the economy to maintain systems to support two different types of central bank currency” and thus if people took up the new CBDC and cash use fell, “there might be an argument for removing cash (including to ensure that it was not facilitating illegal transactions)”.

While the report concludes that at present there does not seem to be a strong public policy case for a retail CBDC, if the RBA feels it needs to go below zero interest rates to help us, then that public policy case may become stronger.

Until next time,

Bron Suchecki
ABC Bullion

If you have any questions or feedback about this week’s report, we would love to hear from you. You can contact Bron Suchecki (@bronsuchecki) directly on Twitter, otherwise please feel free to send us an email at [email protected], or call us during trading hours on 1300 361 261.

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