Insights

Tide Begins to Turn on Global Bond Yields

09 November 2021

While the Reserve Bank of Australia kept the official cash policy rate unchanged at its record low 0.1%, at its monetary policy decision on 2 November, importantly it removed its policy around yield curve control (YCC). While anticipated by the market in recent weeks, it has resulted in a sharp increase in short maturity bond yields. This stimulus strategy was introduced in March 2020, in which the RBA buys Australian government bonds, to anchor the 3 year yield at the target 0.1% level.
With that anchor now gone, the yield of the benchmark 3 year bond (2 ¾ 04/21/2024) spiked to almost 0.8% settling at 0.72%. ¹ Building inflationary pressures added to the move as October’s annual trimmed mean inflation rate, released on October 27th, rose to 2.1%, the first time it has been back in the target 2-3% band since 2015.
While the RBA conceded that there is now potential for higher rates in 2023, it does not expect an increase in the cash rate in 2022 based on the latest data. It is prepared to look through spikes in the inflation rate until inflation is sustainably back in the target range, for which wage growth will also have to move materially higher than it is now.
Even though Australian bond markets have pared back some of the most aggressive bets for early hikes post the meeting, the change in sentiment and narrative has been markedly sharp, especially given the RBA only last month reiterated that conditions for a rate increase were unlikely to be met before 2024.
Thankfully, the faster-than-expected vaccination take up in recent weeks have allowed Australia’s cities to reopen from lockdowns, and with government support stopping unemployment from climbing to high levels, the backdrop remains firm for a robust recovery late this year and into 2022. RBA expects GDP growth to be back on its pre-Delta path by middle of next year, growing by around 5½ per cent over 2022 and by around 2½ per cent over 2023.
This repricing of central bank rate expectations needs to be seen in a global context. The Federal Reserve has initiated tapering, but despite looking like it might raise rates, the Bank of England surprised the market by holding rates at record lows. The European Central Bank has been facing challenges to convince markets to keep borrowing costs low. Short-end yields have been spiking around the globe over the past month, with investors slowly coming to terms that the acceleration in inflation is going to last longer than initially expected.
Sharply rising interest rates across the Australian curve, as investors demand more risk premia for inflation and growth recoveries are likely to negatively impact the value of fixed rate bonds going forward and particularly for longer dated bonds which are subject to greater price sensitivity from changes in interest rates.
Floating Rate Notes (FRN’s) are therefore attractive again as their periodic reset to a spread over the Bank Bill Swap Rate (BBSW) or the effective base rate will result in higher coupons. With the rate cycle having likely turned globally and now also in Australia, floating rate bonds can enable investors to earn higher income over time without the threat from the impact of interest rate duration.

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