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Interest Rate Commentary

Last week, domestic inflation data for the September quarter beat expectations with the headline Consumer Price Index (CPI) rising 0.7% quarter-on-quarter versus estimates of 0.5%. More importantly, core inflation (which strips out volatile items including commodities) increased by 0.35% for the quarter and 1.5% for the year which is in line with the RBA’s year-end forecasts. Due to this revelation and the recent surge in commodity prices, markets are pricing in almost no chance of a rate cut in tomorrow’s RBA meeting. Additionally, given that we are in the home stretch of the US presidential election, we expect Fed will follow suit and also leave rates unchanged this Thursday.

As a result of last week’s revised inflation expectations (lower probability of future rate cuts), the 10-Year Australian Government Bond Yield experienced a significant sell-off reaching a new high of 2.393% on Friday. This change was also driven by global factors as the 10-Year US Government Bond yield also reached a 5-month high of 1.853% on Thursday driven by tapering bond demand expectations.

Yields across the curve remain low compared to long term averages. In November 2015, there was a progressive increase in the Australian 10-Year bond 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 dropped 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 since collapsed to reach a low of 1.373% on the 2 August 2016. On the 28th of November 2016, the ASX 30 Day Interbank Cash Rate Futures November 2016 contract was trading at 98.515 indicating a 6% expectation of an interest rate decrease to 1.25% at the next RBA Board meeting (down from 16% last week).