Daily Commentary BY THE CURVE TEAM –

Bonds Go Boom as Yields Break higher

4th of October, 2018

The combination of strong data and hawkish comments from the Fed has seen bond yields in the US break higher. This is important not only for both global markets and the economy but Australia’s own setting of monetary policy.

Bond yields started their march higher overnight after some unquestionably strong data was released to kick off the US session.

The private ADP employment report for September came in well ahead of estimates at 230,000 (est 184,000), pointing to upside risks for Fridays nonfarm report. The ISM non-manufacturing Index was also strong, rising from 58.5 to 61.6, a new record high since the series began over 20 years ago.

Yields continued to rise throughout the session and just as the move looked to be fading, Fed Chairman Powell took to the stage. While he initially said that rates were still accommodative and that the Fed is moving towards neutral, it was his comment that they may need to go past neutral that got the market’s attention.

The US 10 year yield finally broke through resistance at the close and hit its highest level since 2011. With the US economy going from strength to strength and the Fed likely to hike 4 more times over the next 12 months, interest rate differentials are going to have a huge impact over the months ahead.

Along with rising yields, the USD gained the ascendency once again after softening the past few weeks. That has broad implications for not only the rest of the globe and emerging markets, but is an important input into Australia’s monetary policy settings.

A stronger USD and lower AUD can be a good thing for the Australian economy. It supports our exporters, brings in tourism and makes our university education more attractive.

However a falling AUD and rising offshore interest rates make offshore borrowing more expensive for Australia’s banking institutions who rely on offshore funding. This adds further strength to the headwinds facing the housing market which is currently poses the biggest risk to the outlook for the RBA.

While on the housing market, data yesterday confirmed that the peak in new housing construction is now well behind us as new building approvals sank 9.4% in August. Approvals are now down 27% from their peak in late 2017 and likely to head lower.

Today we get an update on trade with the August trade balance set for release.

David Flanagan

Director - Interest Rate Markets