Transcript of Question & Answer Session Global And Domestic Influences on the Australian Bond Market

First question is if there's a sell-off in global bond yields could this also lead to precipitous falls in equity markets as those markets are just below discount?

I don't know what's priced into equity markets at the moment, to be honest. Depends why bond yields sell off; is it because the global outlook actually looks better? Then arguably that validates equity market pricing. But one can consider that there's probably not – the discount rate across all asset classes is probably reasonably low at the moment, so if the discount rate goes up in fixed income or the term premium goes up in fixed income markets, you might see the same sort of thing in other asset markets. But predicting the future direction of asset prices – which is what you guys are all paid to do – is fraught.

The next question is, oh I've got a mike now. With 10-year real yields near zero and even negative, have bonds lost their usefulness in determining what growth will be in the long term?

Well that's partly what I was talking about today. So if you – I still think the crudest and most useful way of working out where bond yields should be in the medium term is something around about, in nominal terms at least, is nominal GDP with a discount. I still think that probably works and so in real terms it's real GDP with some adjustment for a discount rate. As I was saying earlier, I think the thing which has moved the most is that discount rate or the scarcity premium for fixed income. If you can work out what that premium actually is then you can still back that out to work out what expectations are about medium-term growth developments. But the most troublesome part of that equation is working out what that discount rate is. That's almost certainly changed. Whether it's changed temporarily or permanently, that's the open question.

There are a couple more through the interactivity feature, but we should probably see if there's anyone in the audience who wants to raise a hand before I do the last couple here. Got a microphone here.

Mr Robertson.

There will be a microphone on its way.

Guy, you mentioned that globally, you might have been present in the market – anyone who hasn't been in markets for a decade probably hasn't seen the Fed tighten. Is it credible for the Fed to tighten when their inflation, you know current inflation is low. That seems to be one of the things that people are relaxed about, that inflation in the US is much lower than it used to be, it's not obviously about to rise, and you know the Fed hiking is not on everyone's radar because inflation is so low and has been so stable.

I mean I don't want to get into predicting what other central banks are going to do. The only thing which slightly surprises me if I look at market pricing at the moment is, as best as I can tell, the Fed rhetoric on what they're intending to do has been pretty much exactly the same for the last six months, now whether people listen to that is up to them, but I would generally listen to someone who's actually got control over what they're actually going to do. But the rhetoric hasn't changed, broadly speaking the data has validated the rhetoric, inflation is a little low at the moment, a fair chunk of that is to do with lower oil prices. As I said earlier, oil prices I don't think are going to keep on falling by 50 per cent in a short period of time over the next few years. So the effect of oil prices on inflation probably is temporary, that's again if you listen to what the Fed says, that's what they're expecting. So I don't want to try – I don't understand market pricing around the Fed's decision, I won't to try to validate it or invalidate it, all I would say is I would probably listen to the people who actually have control over what they're actually going to do and hear what they're saying and base my expectations around that.

Maybe just time for one more. There are too many to get through, so apologies to people who aren't getting questions answered but there's at least a dozen on here. Let's end with: would Guy buy German bonds today?

Well so we have Bunds in our reserves portfolio, so the answer to that question is we do hold them. As I said it's an interesting challenge for reserve managers just as it is for other asset managers, what you do, how you think about negative yields. I mean we hold the level of reserves we do for a reason, which is to give us the capacity, you know for a number of reasons, but including to intervene in the market. If those reserves are shrinking, it probably doesn't mean that we've got what we want – you know, that's a consideration we have to take into account. So it is something which we have to think about and as I said it's a challenge for us and other reserve managers just as it is for asset managers in general.

Okay we might just have time for one more. I know that Q&A is valued by a lot of people and there's a lot here so final one definitely. You say there's a debate on whether reduced market making has gone too far, what's your view?

I – so the point I was trying to get is I think that's an open question. My view – I don't think – if we see a sell off in markets, coming back to Rory's question, when the Fed raises rates undoubtedly that will be blamed on the reduced capacity of market making even though when market making capacity was larger in ‘94 we still had a pretty decent sell off then as well. So it will be blamed for a lot of things which it isn't actually responsible for, and would have happened regardless. Some reduction in market making capacity was the intent. Liquidity provision or market making provision – provision of market making services was under priced in 2007, whether it's now too expensive or more fairly priced I think is debatable. So I think, as I said I think it's very much an open question.

The other thing I suppose I'd point out is that some of that reduction in market making capacity was the effect of regulation. Some of it was because banks just decided this wasn't a profitable business line to be in any more, again indirectly or directly because of regulation, but not all of it is the function of the regulatory environment. As I said I think we'll have to wait and see, seeing what happens when the Fed raises rates, I don't think it's actually going to be a good test of the overall market making capacity of the system.

The other thing which I think needs to be taken into account is there are a number of market initiatives going on, particularly buy side to buy side trading and particularly in the fixed income space and particularly in the electronic fixed income space, which are moving to reduce some of those transaction costs. Electronic trading in fixed income particularly in anything outside standardised products like Treasuries is still, I would say, in its infancy and we're going to see quite a lot of evolution on that front over the next year or two which will affect overall transaction costs and will affect the way that fixed income asset managers can go about adjusting their portfolios in the future. So just because there is a reduction in capacity on one side doesn't mean the overall capacity is necessarily going to be reduced. And particularly, as I said, you know bypassing the intermediaries and going much more buy side to buy side I think is almost certainly going to be a much bigger feature of the fixed income landscape than it has been in the past, which will mitigate some of that reduction in overall market making capacity.