Interest Rate Commentary

The 10-Year Australian government bond yield fell to 1.98% in early trading this morning (from 2.00% at Friday close). This was a function of a global bond market rallying last week following numerous central bank meetings with the US 10-Year rate falling 0.10% to 1.61% on Friday.

Firstly, the BoJ announced a change to its policy framework by introducing “yield curve control” of both short and long term interest rates. The BoJ will continue to buy ¥80 trillion of bonds a month targeting a short-term deposit rate of -0.1% but for the first time will now also target long-term bond yields, aiming to keep them at zero from around -0.07% (at the time of the announcement). The BoJ move is intended to steepen their yield curve, or widen the spread between short- and long-term bonds, in a bid to help banks and pension funds which have suffered from low interest rates.

Then, as markets expected, the Fed added to the positive tone by voting (7-3) to keep interest rates unchanged, while leaving the option to hike by the end of 2016 open. According to the FOMC, “the case for an increase in the federal funds rate has strengthened but decided, for the time being, to wait for further evidence of continued progress toward its objectives”.

On Thursday the new Governor (Mr Phillip Lowe) of the Reserve Bank of Australia (RBA) made his first appearance as Governor before the House of Representatives Standing Committee on Economics. Mr Lowe’s opening remarks indicated a continuation of current monetary policy targets with the RBA seeing a low and stable inflation as the best contribution it can make to promoting growth in activity, jobs and income via a flexible 2‑3% inflation target the best way to deliver those outcomes. Mr Lowe also noted that the commodity headwinds are easing with some ¾ of the decline in mining capex has occurred and that if recent increases in commodity prices are sustained the drag on incomes will come to an end. Mr Lowe also stated that it is “very unlikely” that the RBA will run out of policy ammunition and that non‑conventional policy was “unlikely” to be used, government borrowing to boost infrastructure spending was desirable, and a further rate cut was “possible” (depending upon international factors, inflation, employment, housing trends).

Lastly, the Reserve Bank of New Zealand (RBNZ) also held rates unchanged despite a high exchange rate continuing to place pressure on the export and import-competing sectors of the economy (the same issues facing Australia).

The domestic yield curve over the week flattened slightly as a result and overall yields across the curve remain low compared to long term averages. In November 2015, there was a progressive increase in yield from ~2.60% to a high of 2.99%. But since then, the flight to quality meant the 10-year yield gave back the changes in Q4 2015 and more recently the Australian Government 10-Year Bond Yield has continued to drop to record lows (new low of 1.819% as at 2 August 2016). The 3-year bond has followed a similar pattern and broke out of its yield range (1.90 – 2.10%) in November / December 2015 reaching a high of 2.18%. It has since collapsed to reach a low of 1.373% on the 2 August 2016. On the 23rd of September 2016 the ASX 30 Day Interbank Cash Rate Futures October 2016 contract was trading at 98.51 indicating a 5% expectation of an interest rate decrease to 1.25% at the next RBA Board meeting (unchanged from last week).