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Interest Rate Commentary

Yield curves are steepening across the globe and Australia is no different. Stoked by fiscal changes inflation is the primary driver and the next focal point is the Fed. Pricing for a December Fed funds rate hike remains firm at 80%, supported by comments from several FOMC officials recently.  FOMC voter Bullard, as well as non-voters Lacker and Williams, have suggested the Fed is on track to raise rates at its 15th of December 2016 meeting regardless of the US political backdrop.

When the Fed hiked around 11 month ago, this precipitated a meaningful spread correction.  At the moment, spreads are starting from a lower level vs last year (around 0.12% lower), which suggests that spreads are not sufficiently pricing broad macro risks.  We’re increasingly becoming cautious on credit and see headwinds building.  The technical environment – the supply of and demand for credit by investors remain supportive – however we remain wary of widening pressure if the Fed pulls the trigger and hikes next month.  We expect corporates to remain well supported on scarcity, while financials will see some potential spread pressure.

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 11th of November 2016, the ASX 30 Day Interbank Cash Rate Futures November 2016 contract was trading at 98.510 indicating a 5% expectation of an interest rate decrease to 1.25% at the next RBA Board meeting (down from 10% last week).