The Pak Banker

Cen­tral banks fac­ing up to threat of ris­ing yields

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Re­fla­tion trades reached a fever pitch in Aus­tralia's bond mar­kets Mon­day in a burst of ac­tiv­ity that will be hard for global pol­icy mak­ers to ig­nore. Ten-year yields climbed the most since the height of the mar­ket dis­lo­ca­tion in March 2020, while bench­mark three-year yields inched fur­ther above the Re­serve Bank of Aus­tralia's 0.1% tar­get. And this was after the RBA ended a two-month hia­tus by step­ping back into the mar­ket to pur­chase A$1 bil­lion ($790 mil­lion) of the shorter-date debt.

The moves un­der­score the challenge to cen­tral banks as they strive to keep bor­row­ing costs low for years to come while in­vestors po­si­tion for a more im­me­di­ate re­turn of in­fla­tion. Global vac­ci­na­tion pro­grams and talk of an­other com­modi­ties su­per­cy­cle have put Aus­tralia at the fore­front of bets for re­bound­ing growth and ris­ing prices, mak­ing the RBA's job par­tic­u­larly dif­fi­cult. But it's un­likely to be unique.

"Com­mod­ity prices are show­ing us a clear re­fla­tion­ary en­vi­ron­ment," said Chris Rands, a port­fo­lio man­ager at Nikko As­set Man­age­ment in Syd­ney. "This is all about a global re­fla­tion story -- the flow of pos­i­tive vaccine news is say­ing that 'this isn't crazy'." Ex­pec­ta­tions of more eco­nomic stim­u­lus from the Bi­den ad­min­is­tra­tion and pos­i­tive signs on con­tain­ing Covid-19 are pushing rates higher glob­ally, with the U.S. bench­mark 10-year yield hit­ting a one-year high of 1.39% in Asia trad­ing.

Aus­tralia's three-year yield edged up to 0.13% Mon­day while the 10year yield jumped 17 ba­sis points to 1.6%, a level last seen on March 19. Ex­clud­ing that day, it's the high­est 10year yields have been since mid 2019. While the cen­tral bank has sig­naled that rates won't be­gin ris­ing for at least three years, money mar­kets are now pric­ing in about a 30% chance of a hike by mid next year.

"It's en­tirely rea­son­able for mar­kets to start pric­ing in some risk of the RBA hik­ing rates," said Prashant New­naha, se­nior rates strate­gist at TD Se­cu­ri­ties in Singapore. "Mar­kets are go­ing to price in in­creas­ingly higher odds of the RBA hav­ing to pull the trig­ger be­fore their three years are up."

Europe has also been caught up in the bonds sell­off, with Ger­man 10-year yields, the re­gion's bench­mark, climb­ing to the high­est since mid 2020. As the euro area's yields track those on Trea­suries higher, it faces an "un­de­sir­able tight­en­ing of mon­e­tary con­di­tions," ac­cord­ing to Erik Nielsen, group chief econ­o­mist at Unicredit SpA.

If they con­tinue to climb in com­ing weeks, "it'll leave the ECB no choice but to step up their pur­chases," Nielsen wrote in an in­vestor note. "I would be sur­prised if we don't hear the first warn­ing shots from key mem­bers within the next cou­ple of weeks."

Some Fed of­fi­cials, though, are will­ing to ac­cept the ris­ing yields as a sign of op­ti­mism in the re­cov­ery. That's the view of Fed­eral Re­serve

Bank of New York Pres­i­dent John Wil­liams, as ex­plained in an interview with CNBC.

And Aus­tralia's pol­icy mak­ers may yet dis­ap­point rates traders pre­par­ing for a shift.

"The cen­tral banks fear that the bond mar­ket is jump­ing at what will be a tran­si­tory hike in in­fla­tion over the months ahead," said Shane Oliver, chief econ­o­mist at AMP Cap­i­tal In­vestors Ltd. in Syd­ney. "They would rather look through any short term spike in in­fla­tion, and al­low the re­cov­ery to use up spare ca­pac­ity and gen­er­ate higher wages growth be­fore tight­en­ing -- and this may still be sev­eral years away."

"Ris­ing yields are likely to pres­sure fur­ther en­large­ment of the RBA's re­cently-ex­panded bond pur­chase pro­gram, in an ef­fort to limit fur­ther cur­rency ap­pre­ci­a­tion. There is also an in­creased risk of an ear­lier than planned an­nounce­ment of a switch the yield tar­get to the Novem­ber 2024 bond.."

Still, Aus­tralia's suc­cess in con­tain­ing Covid-19 has rapidly re­stored sen­ti­ment among house­holds and busi­nesses. That's helped un­em­ploy­ment fall more than a per­cent­age point from its pandemic peak of 7.5%, and ris­ing prop­erty prices and cashed-up con­sumers are a po­tent mix for eco­nomic ex­pan­sion.

This prompted West­pac Bank­ing Corp. econ­o­mist Bill Evans to last week raise his fore­cast for Aus­tralia's 10-year yield to 1.9% by the end of this year, from 1.55% ear­lier.

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