The bond market has no doubt — US interest rates are going up

The bond market believes US Federal Reserve chief Jerome Powell will ignore the clear US signs the economy is slowing.

While the world share markets pontificate about what Federal Reserve chief Jerome Powell will signal on US interest rate trends at Jackson Hole, the bond market has no doubt — US interest rates are going to continue to rise.

The August dumping of US bonds signals the bond market believes Powell will ignore the clear US signs that the economy is slowing. At the start of August the 10 year bond yield was 2.6 per cent but on the eve of Jackson Hole it is it has blown out to 3.1 per cent — a massive sell off of bonds in one month.

Here in Australia we are almost certain to follow the US partly because our economic signals are not as advanced as the US and there are disturbing signs that wages are about to break out.

In the US, housing starts are down by almost 20 per cent and house prices have started to crumble. The higher interest rates are also clearly impacting retail sales so Powell has plenty of evidence to put a brake on rate rises which comforts the share market.

Therefore if the bond market signals prove correct then it will kindle increase selling on share markets around the world.

Here in Australia the Reserve Bank can see in the official figures a disturbing trend in wages. According to former Reserve Bank and current Indeed economist Callam Pickering, Australian wages are growing at their fastest pace in eight years and, with the unemployment rate at a 48-year low, appear likely to strengthen further over the remainder of the year.

Callam Pickering. Picture: Supplied

But behind the official figures there are clear signs Australian interest rate rises are already starting to impact the economy.

Unemployment and inflation are lag indicators. Housing starts are a much better forward indicator. But in Australia, unlike the US, the official statistics don’t show what is really happening in the home building industry.

As I set out last week the fall in dwelling orders has been much more severe than the US and that slump will gradually find its way into the official statistics.

The CBA bank this week highlighted another forward indicator that is also yet to show up in official statistics.

In Australia, the S&P Global Australia Composite PMI Output Index is a GDP-weighted average of the Commonwealth Bank Manufacturing Output Index and the Commonwealth Bank Services Business Activity Index. In August. the index fell below 50 which indicates a contraction in business activity.

The Reserve Bank describes the path to keeping the economy on an even keel while lifting interest rates as “a narrow one and subject to considerable uncertainty”.

The CBA bank says the Composite PMI index trends highlight just how “narrow” that path is because they signal that if the RBA continues to tighten policy aggressively the private economy will likely go backwards.

That is not what the RBA is trying to achieve. The Australian services sector dwarfs the manufacturing sector so it largely drives the Composite PMI.

Demand in Australia’s services sector actually went backwards over August while weaker growth in activity in the manufacturing sector was also posted.

The CBA says the August PMIs, are a “timelier read” on the private economy that many other indicators. The PMI advance warning has been confirmed by a slump in business confidence to its lowest level since April 2020.

If the Federal Reserve follows the bond market prediction and the Reserve bank does not follow then it will impact the Australian currency.

The looming Australian wages break out is another factor pushing the Reserve Bank towards higher rates. But at the coal face in housing and service areas there is a different story starting to emerge.