Reflections reached a fever in Australia’s bond markets on Monday in an outburst of activity that will be difficult for global decision-makers to ignore.
Ten-year interest rates climbed the most since the height of the market disruption in March 2020, while benchmark three-year interest rates further emptied above the Reserve Bank of Australia’s 0.1% target. And this was after the RBA ended a two-month hiatus by stepping back on the market to buy A $ 1 billion. ($ 790 million) of the shorter-term debt.
The movements underscore the challenge for central banks as they strive to keep borrowing costs low in the coming years, while investors position themselves for a more immediate return on inflation. Global vaccination programs and talk of another commodity supercycle have put Australia at the forefront of betting for rising growth and rising prices, making the RBA’s job particularly difficult. But it is unlikely to be unique.
“Commodity prices show us a clear reflection environment,” said Chris Rands, a portfolio manager at Nikko Asset Management in Sydney. “This is about a global reflection story – the flow of positive vaccine news says ‘this is not crazy’.”
Expectations of more economic stimulus from the Biden administration and positive signs of containing Covid-19 are pushing interest rates higher globally, as the US benchmark 10-year return hits a one-year high of 1.39% in Asian trade.
Australia’s three-year interest rate rose to 0.13% on Monday, while the 10-year rate jumped 17 basis points to 1.6%, a level last seen on 19 March. Aside from that day, it is the highest 10-year interest rates since mid-2019. While the central bank has signaled that interest rates will not start to rise for at least three years, money markets are now pricing approx. 30% chance of an increase in the middle of next year.
“It is quite reasonable that markets are beginning to price some risk on RBA migration rates,” said Prashant Newnaha, senior rate strategist at TD Securities in Singore. “The markets will price in ever-higher odds for the RBA to pull the trigger before their three years are up.”
Europe is also trapped in the bond offering with German 10-year returns, the region’s benchmark, which has risen to its highest level since mid-2020.
As the euro area’s yield tracks higher on government bonds, it is facing an “undesirable tightening of monetary conditions”, according to Erik Nielsen, CEO of Unicredit SpA.
If they continue to climb in the coming weeks, “it leaves the ECB with no choice but to increase its purchases,” Nielsen wrote in an investor note on Sunday. “I would be surprised if we do not hear the first warning shots from key members within the next few weeks.”
However, some Fed officials are willing to accept rising interest rates as a sign of optimism in the recovery. That’s the view expressed by President John Williams of the Federal Reserve Bank of New York in an interview with CNBC on Friday.
And Australia’s policy makers may still be able to dispose of rate traders preparing for a shift.
“Central banks fear that the bond market will skip what will be a temporary rise in inflation in the coming months,” said Shane Oliver, chief economist at AMP Cital Investors Ltd. in Sydney. “They would rather look at any short-term rise in inflation and let the recovery use unused capacity and generate higher wage growth before tightening – and that could still be several years away.”
What Bloomberg Economics says …
“Rising interest rates are likely to push for further expansion of the RBA’s recently expanded bond repurchase program in an attempt to limit further exchange rate depreciation. There is also an increased risk of an earlier than planned announcement of a change in the interest rate target to the bond from November 2024. ”
– James McIntyre, economist
Click here for the full note.
Read more: Bond traders can see RBA Yield Curve Controls use by date
Yet Australia’s success in containing Covid-19 has restored sentiment among households and businesses. It has helped unemployment fall more than one percentage point from its 7.5% pandemic peak, and rising property prices and consumers charged are a strong mix for economic expansion.
This prompted Westpac Banking Corps economist Bill Evans last week to raise its forecast for Australia’s 10-year interest rate to 1.9% at the end of this year from 1.55% earlier.
In addition to purchases to control the three-year return, the RBA is still making regular purchases of bonds that are longer dated, under quantitative easing, and bought an additional $ 2 billion of them on Monday.
(Updates with Europe, USA in paragraphs 8-11.)
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