Daily Commentary BY THE CURVE TEAM –

Rates Rising Ahead of Fed Meeting

20th of September, 2018

Market’s sanguine response to the escalation of the trade war between the US and China continued overnight. While equities remained buoyant and emerging markets climb off the mat, it is rising interest rates which are worth watching.

China’s soft response to the trade war escalation by the US has seen positive sentiment across markets continue overnight. Comments from Chinese Premier Li Keqiang that China won’t weaponise its currency by devaluing it to support exports helped limit the potential fallout from the trade tensions.

While markets are sanguine on the prospects of a negative fallout from the trade war, it is rising interest rates that are worth keeping an eye on.

Over the past few weeks we have seen long term rates in the US climb more than 25bp and dragging with them the long rates of other countries such as Australia.

There are a number of possible reasons that longer term rates are suddenly rising again.

It could be the growing hawkish rhetoric from a number of Fed members, even those who have had a dovish tilt for some time.

It could be that the tax induced bid on bonds which saw fund manager pull forward demand ahead of tax changes is evaporating.

It could be the ballooning budget deficit in the US and subsequent funding task that the US Treasury will have over coming years.

Most likely it is a combination of all three.

As a result of the lift in US long term rates, our curve has also steepened, even though we have seen no change in the outlook from the RBA around the future direction of monetary policy.

The 1 year sway has lifted 7bp over the past week or so while the 5 year swap has lifted more than 20bp. While this lift in swap rates has yet to be reflected in deposit rates for 1 year, 5 year deposit rates are starting to climb.

With the US Treasuries funding task likely to crowd out other borrowers, including Australian banks borrowing offshore, rising deposit rates are going to have increasing pressure on Bank’s overall funding costs.

So while the RBA is in no rush to lift rates, the rising tide offshore will continue to have an impact locally.

David Flanagan

Director - Interest Rate Markets