Daily Commentary BY THE CURVE TEAM –

Long Term Rates Hold Key to the Outlook

20th of November, 2018

It was another wobbly start to the week with equity markets under pressure and currency markets all over the place. However the focus should be on where long term interest rates are going.

Concerns over the tech sector, especially Apple, and the ongoing uncertainty over the US-China trade battle hit equity markets again overnight. It looks like markets will re-test the lows from October and what happens from there could be key for the medium term outlook.

Currency market correlations broke down overnight. The GBP marked time as Brexit deliberations in the UK continue to drag on. The AUD and NZD were under pressure as equity slid which also saw the JPY rally. The interesting one was EUR rising which is somewhat at odds with the moves seen in other markets. It could just be a short term phenomena of the start of a change in the outlook.

While those moves are interesting, the space to really watch is long term interest rates. Longer rates were heading higher, driven by the US as short positions accumulated ahead of the rise in the supply of bond issuance from the US Treasury. As the supply has come on line we have seen shorts covering their positions which has seen the 10 year US Treasury rate consolidate over the past few weeks between 3.05% and 3.25%.

That is important as next time rates start to head up towards 3.25% there is a greater probability of a sustained move higher towards 3.50% and potentially beyond and speculators start to ramp up short positions once again.

How this evolves has broad implications for many markets around the globe. Higher rates both weigh on other asset prices as well as making debt more expensive as many borrowing rates are tied to US Treasury rates.

In Australia it is important too. As offshore rates rise and the US Treasury continues to ramp up borrowing, it crowds out our banks and makes it harder and more expensive for them to raise funds offshore. That increases the demand for domestically sources funds, driving up the weighted average cost of funds. A rising cost which they eventually have to recover through raising mortgage rates. It also affects the availability of credit.

The availability and cost of credit is crucial not only for the housing market is Australia which is already under immense pressure but the health of the broader economy as well.

David Flanagan

Director - Interest Rate Markets