Daily Brief – A lesson from the RBA?

A lesson from the RBA?

Overnight the Reserve Bank of Australia raised rates by 25-basis points. Stay with me even if you’re not an AUD observer, as this event is likely to hold lessons for regional and global markets. What was important about this decision is that, despite being widely anticipated, there were three dissenting voters who wanted to see the cash rate unchanged. Ordinarily, there are two potential market reactions to this: move with the RBA and price out some further hikes or have a tantrum and blow out longer dated yields and factor in a higher terminal rate.

In recent months we have seen an element of the tail wagging the dog in global bond markets: that is to say that the market has been leading the central bank about where it needs rates to be. That makes the latter, more destructive, outcome of a tantrum more likely. The lesson to be learned is that the bond market so far has delivered the former, pushing yields slightly lower across the curve. Okay, the AUD has suffered as a result, as would be expected under such an outcome, but it still shows the central bank is leading markets following this decision, not vice versa.

Many major central banks including our own BoE are expected to hike rates by some 1% by the middle of next year. The public and policy makers alike are quite rightly questioning: can the public and economy alike afford it? We could read into the RBA decision and suggest that if the answer is no, they cannot, those central banks could lead the market into a lower path more consistent with growth as long as inflation is projected to come down. However, with so much high yielding national debt in abundance globally, it may have been a case of ample substitutions that allowed the RBA to emerge unscathed from a dovish decision. If this is the case, this episode may not be repeatable by other central banks across the globe.

Discussion and Analysis by Charles Porter

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