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Interest Rates Commentary

The minutes from the Reserve Bank meeting released last week showed that the rate cut was line ball while minutes from the Federal Reserve meeting confirmed that June is “live” for the next rate hike.

 

The key message from the RBA was that they are concerned by the sudden disinflation and worried that it could become entrenched. This is a clear sign that they are responding to a mandate (2-3% CPI) which may be out of date. It is our feeling that this commentary will lead to further cuts even though the labour market is relatively stable.

 

On the other side of the globe a Federal Reserve policy maker indicated last week that financial and economic conditions have moved in their favour and it is on the verge of increasing interest rates next month. For the Fed to raise rates it has set preconditions relating to the jobs market, inflation and other signs of an economic rebound in the second quarter and as of “as of right now seem to be . . . on the verge of broadly being met”.

 

Between November and December 2015 there was a progressive increase in yield from ~2.60% to a high of 2.99%. But since 7 December 2015 the flight to quality meant the 10-year yield gave back the changes in Q4 2015 and on 16th May 2016 the Australian Government 10-Year Bond Yield dropped to a record low of 2.22%.

 

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% on 7 December 2015. It has since collapsed to reach a low of 1.54%. On the 20th May 2016 the ASX 30 Day Interbank Cash Rate Futures June 2016 contract was trading at 98.275 indicating a 13% expectation of an interest rate decrease to 1.50% at the next RBA Board meeting (down from 23% last week).