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  • Following the COVID-19 shock, the Reserve Bank of Australia (RBA) is keeping a close eye on market assets and investments to ensure they are appropriately valued
  • When risk-free rates are low, asset values rise, which is part of the monetary transmission process, with RBA’s Marion Kohler saying the bank will keep an eye on yield chasers
  • Search for yield behaviour is where investors bid up the price of risky assets to the extent that risk may no longer be adequately priced, Ms Kohler says
  • “This, in turn, increases the risk of a sharp correction down the road,” Ms Kohler says

The Reserve Bank of Australia (RBA) is keeping a tight check on market assets and investments to ensure they are suitably valued following the COVID-19 shock.

Concerns about the economic impact of COVID-19, as well as the corresponding increase in uncertainty, induced a rapid adjustment in securities prices, according to Marion Kohler, RBA head of domestic markets.

“It’s important to closely monitor risk premiums to judge whether asset prices appear to be sensibly valued,” she said in a virtual speech to the Australian Securitisation Forum.

Concerns over the economic repercussions of COVID-19, as well as the concomitant surge in uncertainty, induced a substantial adjustment in securities prices, according to Ms Kohler, but the time of “volatility was brief”.

“Risk premiums have increased in the initial phase by much less than during the global financial crisis, and were elevated for a shorter period,” she said.

When the pandemic was declared by the World Health Organisation on March 16, the ASX 200 declined by 10 per cent, the largest one-day fall in over 30 years. However, conditions stabilised shortly after government stimulus announcements on March 19.

“Overall, the adjustment in pricing as the COVID-19 pandemic spread was sharp, but also brief,” she said. “During the global financial crisis, volatility in equity prices stayed elevated for several quarters, as did risk premiums for bonds and equities.”

When risk-free rates are low, asset values rise, which is part of the monetary transmission process, with Ms Kohler the bank will keep an eye on yield chasers.

“However, as we’ve highlighted in recent Financial Stability Reviews, over time it also raises the prospect of ‘search for yield’ behaviour, where investors bid up the price of risky assets to the extent that risk may no longer be adequately priced,” she said.

“This, in turn, increases the risk of a sharp correction down the road. So, it’s important to closely monitor risk premiums to judge whether asset prices appear to be sensibly valued.

“While bank bond spreads are around their lowest level in over a decade, it’s difficult to know whether this is not aligned with fundamentals. Measures of equity risk premiums remain within their typical range.”

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