Daily Commentary BY THE CURVE TEAM –

Did The Penny Just Drop?

5th of February, 2018

There was some serious price action Friday night with equity markets suffering heavy losses, the USD rising off its knees and bond rates heading higher yet again. The moves suggests that other markets might have finally caught on to something the bond market has been alluding to since the start of the year.

There was a sea of red across markets on Friday night. The data didn’t seem too out of sync with expectations as the US economy added a further 200,000 jobs in January and wages were up 0.3%. Both results were a little better than expectations but not by a huge margin, 20,000 and 0.1% respectively.

The news was enough to see the selloff in bonds continue, with the US 10 year yield rising into the mid 2.80% range, now up 20bp in the space of a week and 44bp since the start of the year.

The latest uptick in the pace of wage growth combined with the rise in bond yields since the start of the year prompted what appears to be a penny dropping moment for equity markets. The market has for some time been underestimating the FOMC’s outlook and markets pricing still does, but the data Friday night supports the Fed’s dot plot and inflation outlook.

Falls in US markets were in excess of 2.5% with the down falling 666 points, adding to declines earlier in the week. While it doesn’t confirm that the top is in, it does confirm that volatility is on the rise and is likely to be with us for some time.

More importantly for Australia and our own setting of monetary policy was the performance of the AUD Friday night. Already on the back foot as the yield spread to the US slowly evaporates, the bounce in the USD drove a sharp fall in the AUD. After trading up above 0.81 only a week prior, the AUD is now sitting more than 2 cents lower with few signs of support.

This will be an important consideration for the RBA in the context of overall monetary policy conditions when they meet tomorrow for the first time since December. I will have a full preview of the RBA’s February meeting tomorrow morning.

David Flanagan

Director - Interest Rate Markets