The bond market is crashing - and it'll affect you

Mon, 08 Oct 2018  |  

This article first appeared on the Yahoo 7 Finance website at this link: https://au.finance.yahoo.com/news/bond-market-crashing-itll-affect-232320713.html 

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The bond market is crashing - and it'll affect you

There are two very important trends unfolding in financial markets.

One is the surge in government bond yields, the other is the free-fall of the Australian dollar.

To the bond market first.

In the US, bond yields – or interest rates – have jumped sharply since Donald Trump was elected President and he took the decision to lock in trillions of dollars of government borrowings to fund a range of tax cuts. When Trump was elected, the 10 year bond yield in the US was around 1.9 per cent, with the 2 year yield around 1.0 per cent. Now, with the US budget being trashed and inflation pressures building, those yields have jumped to around 3.2 and 2.9 per cent, respectively.

Part of this surge in yields is linked to the US Federal Reserve hiking interest rates in reaction to the extreme sugar hit to the economy from the extraordinary fiscal policy easing. It is also engaging in quantitative tightening, which is unwinding the money printing that was instigated in the wake of the banking crisis.

The other part of the jump in US yields is linked to expectations of an inflation surge as the economy is flooded with borrowed government money.

Rising bond yields matter. They increase the cost of borrowing not only for governments, but for business and consumers. At a time when the US economy is at risk of a slowdown, a further sharp rise in yields risk derailing business investment and household spending into 2019.

The rise in US and global bond yields had already impacted on the Australian economy.

The recent rise in mortgage interest rates from most of the banks was linked in part to the rise in the cost of funds – that is, the price banks have to pay to raise capital to on-lend into the Australian market. There is some risk that as the US bond market sells off further, there will be additional pressure on the banks to lift local interest rates, even if the Reserve Bank of Australia leaves official rates on hold.

The rise in US yields at a time when official interest rates are on hold and the domestic economy is on a knife-edge, is undermining the Australian dollar. Having peaked around 81 US cents earlier in the year, it has falling steadily to be holding now just above 70 US cents. If there is any further signs of economic softness into 2019, as seems likely with house prices falling away, the interest rate differential to the US would guarantee a break below 70 US cents and a move to 65 US cents would likely become the new consensus view.

At 70 US cents, the Aussie dollar is at its lowest since early 2016 and is just 2.5 US cents from slumping to the low levels reached during the global financial crisis. For the moment, the fall of the dollar has been orderly. There is no currency ‘crisis’ and its weakness against other currencies, such as the Euro, yen and pound, have been more measured than the fall against the US dollar.

But if the US bond yields keep rising and yields in Australia remain low in line with the softer economy, the Australian dollar could come under considerable pressure.

65 US cents might be a conservative forecast for the near term.

If things get ugly and the US bond market keeps selling off, the Australian dollar could fall even further.

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Don’t fall for the spin - Scott Morrison’s budget surplus is no certainty

Thu, 06 Dec 2018

This article first appeared on the Yahoo Finance web site at this link: https://au.finance.yahoo.com/news/dont-fall-spin-scott-morrisons-budget-surplus-no-certainty-224422761.html 

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Don’t fall for the spin - Scott Morrison’s budget surplus is no certainty

Prime Minister Scott Morrison could yet be guilty of prematurely declaring that his government will deliver a budget surplus in 2018-19.

Sure, tax revenue is growing at a rapid pace and the government is underspending on a range of government services, but there are still seven long months to go between now and the end of the financial year that might yet blow up the surplus commitment.

PM Morrison’s ‘return to surplus’ boast is based, it appears, on hard data for the first four months of the 2018-19 financial year on revenue and spending information from the Department of Finance. These numbers do look strong, at least in terms of the budget numbers and if the trends on revenue and spending continue, the budget will probably be in surplus. Treasury will be factoring in ongoing economic growth, no increase in the unemployment rate and buoyant iron ore and coal prices over the remainder of the financial year. These forecasts and hence the budget bottom line are subject to a good deal of uncertainty, as they are every year.

If, as is distinctly possible, the economy stalls in the March and June quarters 2019, commodity prices continue to weaken and if there are some unexpected increases in government spending, the current erroneous forecasts for revenue and spending could leave the budget in deficit.

Change of view on monetary policy

Wed, 05 Dec 2018

In the wake of the September quarter national accounts, and with accumulating information on house prices, dwelling investment, the global economy and spare capacity in the labour market, I have revised my outlook for official interest rates.

For some time, I have been expecting the RBA to cut the official cash rate to 1.0 per cent, a forecast that has been wrong (clearly) given its decision to leave rates steady right through 2018.

That said, it has been a highly profitable call with the market pricing interest rate hikes when the call was made which has yielded a decent return as time has passed.

My updated profile for RBA rates is:

May 2019 – 25bp cut to 1.25%
August 2019 – 25bp cut to 1.00%
November 2019 – 25bp cut to 0.75%

The risk is for rates to 0.5% in very late 2019 or in 2020

It will be driven by:

  • Underlying inflation remaining below 2%
  • GDP growth around 0.25 to 0.5% per quarter in 2019
  • Annual wages growth stuck at 2.5% or less
  • Global growth slowing towards 3%
  • Labour market under-utilisation around 13 to 13.5%

There are likely to be other influences, but these are the main ones.

AUD, as a result, looks set to drop to 0.6000 – 0.6500 range.