Banks could budge on deposit rates as global bond rout deepens

Panic in the bond market is starting to spread and our big banks will soon come under pressure to lift deposit rates.

Traders James Dresch, left, and Gregory Rowe work on the floor of the New York Stock Exchange, Monday, Nov. 14, 2016. (AP Photo/Richard Drew)

The panic to exit long-term US bonds is not only gathering momentum but it’s also beginning to infect other rates, including American home mortgage rates. If the US bond exodus continues, then the higher yields will start to push Australian deposit interest rates higher, irrespective of what happens to the Reserve Bank’s official rate.

So, let’s look at what is now happening in the US and the potential impact on Australia.

Last night the US 10-year bond yield hit 2.3 per cent compared to 1.77 per cent before the Trump election and a low of 1.36 per cent around June 30. Behind that massive fall in bond prices are big losses incurred by US banks and other bond buyers.

There was some late buying of the 10-year bond last night and the yield slipped back to 2.23 per cent, which is still well above last week’s level. Paradoxically, the 2.23 per cent rate is where it was at beginning of the 2016 calendar year.

For most of 2016, American banks found themselves with increasing deposits as the population became more cautious. At the same time, they were finding it harder to find attractive loan opportunities. So they poured money into US bonds sending yields lower and lower.

If we are going to see a really big rise in US infrastructure spending in the Trump era (I will raise a caution about this below), then that’s going to require more bank lending and this will lead to higher inflation, so, suddenly, long-term bonds are a silly place to have too much bank money.

Accordingly, as Wall Street shares rise in anticipation of Trump spending and higher US inflation, so US banks and others have been exiting longer term bonds creating something of a panic.

Now, some of the suggestions coming out of the Trump camp are that about 85 per cent of the planned infrastructure spending must come from the private sector. That would involve a huge amount of bank funding but I also expect that would also greatly delay the sort of infrastructure rush that markets have been anticipating following Trump’s acceptance speech after the election.

Like US bonds, Australian bond prices, along with infrastructure stocks like Sydney Airport and Transurban plus the property trusts, have also fallen in price. This has boosted yields and is part of a worldwide trend.

Last week, 10-year Japanese government bonds were trading at a negative 0.02 per cent yield, so they had almost crossed over into positive territory after their negative madness. In Germany, the negative aberration in 10-year bonds has now ended and they are trading above 0.3 per cent.

In Australia, bank deposit rates remain very low and there are no signs of them rising.

All the banks were taught a lesson in August when the Commonwealth Bank increased term deposit interest rates sharply. The high rates did not attract vast amounts of extra deposit money. So, quietly, the CBA and the other big banks took most of their deposit rates back to where they had been a month earlier. Some may have even gone lower.

The extent to which the banks rely on local deposits for their funding varies between banks but figures in the 60 to 70 per cent range are the norm among big banks. Small banks often fund all their requirements locally.

Big bank dependence on overseas money is usually between 20 and 30 per cent. The cost of that overseas money is usually between 0.8 per cent and one per cent above the shorter-term local deposit rates. As overseas rates rise, that extra cost is going to increase. And as that occurs, all the big banks will weigh the advantages of “doing a Commonwealth” and raising deposit rates to provide money that is cheaper than overseas money.

But unless they lift the rates much further than the CBA did, the banks will not attract significant funds and if they go too high it will lift their cost base and force up home loan rates.

So, the game goes on and Australian depositors continue to cop it in the neck. But, if the American bond interest rate continued to rise, then something will snap.