Stand-off in Australia’s bond market could redefine rates outlook

There is a tense stand-off happening in Australia’s government bond market that might amount to nothing, or it might amount to everything for the outlook for interest rates.

The minutes of the RBA’s October policy meeting on Tuesday offered no indication that the central bank is on the cusp of rewriting its playbook, said ANZ head of Australian economics David Plank.

There is a tense stand-off happening in Australia’s government bond market that might amount to nothing, or it might amount to everything for the outlook for interest rates.

Bond traders have been in their bunkers watching the horizon for about a week now, waiting for the Reserve Bank of Australia to sail into view, its guns blazing in an attempt to restore order to short-dated bond yields.

So far there hasn’t been any display of firepower by the central bank, and anxiety is high.

In a more technical explanation, as part of its efforts to lower borrowing costs across the economy, the RBA has been diligently keeping the yield on the April 2024 government bond maturity as close to 0.10 per cent as it can for some time. It does this by coming into the market and buying bonds when needed.

RBA Governor Philip Lowe has often referred to the big policy guns the central bank has in its armoury, and this is one of the ways it has chosen to use them through the pandemic.

But since last week, the yield on the April 2024 maturity has been rising. That is partly because bond traders are increasingly sensing a growing global inflation threat that could well wash into prices in Australia over time.

Energy prices are soaring and supply chains supporting international trade are broken. Add to that the massive fiscal stimulus that is about to flow into the US economy, and you have a cocktail for higher prices of all kinds of goods and services that may prove to be anything but transitory.

The yield on the April 2024 bond in question has gone as high as 0.17 per cent in recent days. It doesn’t sound like a big deal, but if the RBA doesn’t step in to push it back down, bond traders will compute that the central bank is preparing to radically shift its guidance on the outlook for interest rates.

Su-Lin Ong, managing director at RBC Capital Markets, said financial markets are feeling out the RBA by pushing the yield on the April 2024 bond higher. Maintaining the yield target is the first line of defence for the central bank, which has signalled to markets quite vigorously that it has no intention to raise interest rates before 2024, she said.

“It is sending a rather mixed message in its silence,” Ms Ong said.

While this is happening, financial markets have begun to price in the prospect of the first interest-rate increase since November 2010 happening sometime in mid to late 2022. Faith in the guidance around 2024 is breaking down quickly.

Should the RBA remain silent, “it is likely to signal some shift in its policy stance and change in its forward guidance,” Ms Ong said.

That would be a monumental change of course for the RBA, especially after Dr Lowe chided markets as recently as mid-September for having the crazy idea that interest rates may rise in late 2022.

An abandonment of the yield curve control target would cascade in a number of directions for the RBA, prompting it to rewrite its economic forecasts and acknowledge that while inflation remains benign in Australia, global trends are hard to resist and the bank must soon be prepared for an inflation fight.

ANZ head of Australian economics David Plank said the RBA is more than likely to break the tension in the coming days.

“We expect the RBA to come into the market in the next day or two, unless the yield drops back sharply by itself. To not do so would be interpreted as a signal that the forward guidance on when the cash rate might move has changed,” he said.

The minutes of the RBA’s October policy meeting on Tuesday offered no indication that the central bank is on the cusp of rewriting its playbook, Mr. Plank said.

While the RBA was a little more upbeat on the economy given that key eastern states are emerging from Covid-19-related lockdowns earlier than expected, the central bank’s narrative that wages growth is set to remain weak argues for a continuance of its dovish policy approach for now, he said.

The Wall Street Journal