by Simon Swanson*
There is a unique 12-18-month window of opportunity for the Australian government to issue long-term debt to support the economy during the COVID-19 crisis and invest for the future.
Even before the crisis, there was a solid case for the Australian Government to issue long-term debt to invest in Australia’s future.
There are many nationally significant projects on the Government’s priority list that require funding and interest rates globally are currently extremely low. A low-yielding 50-year bond could fund a 40-50-year infrastructure investment project that will provide employment and underpin the nation’s economic prosperity.
But exactly how long interest rates will stay this low is uncertain.
In recent months, governments around the world have pledged unprecedented stimulus measures in response to COVID-19, meaning capital markets will have to absorb huge amounts of debt in the next six-12 months. Although the initial impact of COVID-19 on the global economy has been deflationary, governments are likely to adopt more expansionary fiscal policy in the aftermath.
One possible scenario is a shift from a deflationary bust to an inflationary boom in the next few years, particularly if the doctrine of Modern Monetary Theory (MMT) is applied. MMT has evolved over the past two decades and purports that jobs not cash is the answer to economic downturns. It recommends aggressive fiscal expansion funded by the central banks. In these circumstances, long-term interest rates may spike higher.
Locking in low rates
The overarching mandate of the Australian Office of Financial Management (AOFM), the Treasury Department responsible for borrowing money through global financial markets, is to ensure that the Australian government’s financing needs are met cost effectively.
Record low interest rates present a unique opportunity for the government to hedge against the risk of higher interest rates by locking in lower borrowing costs on a significant chunk of debt.
Right now, there is a 12-18 month window of opportunity for the government to issue long-term debt and lock in a better deal for taxpayers.
A number of Australia’s G20 counterparts have already gone down this path. Britain, Canada and Italy have issued 50-year bonds. Mexico offers 100-year debt. Recently, US Treasury – which already issues 30-year bonds – flagged its intention to issue 50-year bonds later this year to finance its ballooning debt and take advantage of low interest rates. It did not rule out the possibility of 100-year bonds, if all goes according to plan.
The Australian Government currently has around $560 billion of debt on issue (not including state and local government debt) and economists estimate that it will need to issue up to $300 billion of government bonds in the next 15 months, according to a recent report in the ‘Australian Financial Review’.
Given the very real prospect of a long-term deficit, if the government must borrow, it should do it for the long-term.
Long bond demand is here today but may be gone tomorrow.
Investor appetite for highly rated long bonds with maturities of 30 years-plus has spiked in recent years and not only from large institutions with long-term liabilities such as insurance companies, superannuation funds and sovereign wealth funds.
Income-hungry retail investors who need to manage a range of risks including longevity are also in the hunt, as Australian Government bond yields continue their slide to all-time lows.
Their search for yield will only intensify with a raft of blue-chip stocks cutting dividends this reporting season. Investors can no longer count on regular dividend payments to prop up their income and sharemarket returns.
Australia needs a long tail of fiscal support
In coming months, the Australian economy will experience its biggest economic shock in 30 years.
It will do so with some real structural vulnerabilities.
For starters, Australian consumer debt levels are amongst the highest in the world while consumer savings are extremely low.
The housing market is over-heated and wage growth is non-existent. It is not hard to see how a major shock to the Australian economy, such as the one currently being experienced, could lead consumers to retreat and trigger a longer-term recession.
The Australian Government’s unprecedented COVID-19 stimulus package aims to support consumer spending over the next six months, but it must find a second lever of fiscal support to sustain the economy for the next few years.
Given it will be some time before governments are able to report a surplus, as they keep large amounts of fiscal stimulus in the market to support growth, Australia should move now to issue long-dated bonds to lock in low rates and a better deal for taxpayers.
*Simon Swanson is the managing director of ClearView Wealth Limited