bond yields up 25bp since 13 june

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    At a time when fixed interest rates are dropping in Australia and honeymoon, introductory rates for new homeloans are coming in @4.99% (today), it is interesting to look at what the bond markets are doing.

    For starters, the Australian yield curve has shifted to an upwards bias. Since reaching the low point of 4.55% last Friday, bond yields have increased by 25bp to 4.8% (marginally below where they were in February 2003, and still below the 5.1% rate of September 2001, and the 5.3% rate of September 2002). What, however, is significant with the current sell-off is that it has come at a time when the FOMC is scheduled (according to speculation) to make a 25bp to 50bp rates reduction at its meeting, next week. Conversely, Australian speculation still centres on the RBA cutting rates by 25bp on 1st July.

    So, if the yield curve is moving towards an upwards bias, and with market speculation still focusing on short-term rates being cut, how can we reconcile these 2 concepts together?

    For starters, if the proposition is accepted that the Bond yield curve is a leading indicator whilst movements in the RBA and FED rates are lagging indicators, then this week's upwards bias points towards future rates' rises being the new, emerging trend.

    Secondly, if market sentiment is leaning towards the proposed cuts' in rates, then this suggests that the bonds market does not expect any further easings beyond those currently proposed, and that these will be the last of their kind in the current easing cycle.

    This was the case in each of 1993, 1998 and again in 2002. And, in 2H03, I expect this to again be the case, with bonds pointing to a prospective 200 - 250bp gain in yield value over the next 18+ months (ie: from the point of first rise in cash rates) which would take bond yields to ~7% (and cash rates to ~6.5%) by mid-1H05.

    So, all things considered, the bonds' market is already starting to factor in for future rises in interest rates. As a consequence of this, the interest rate outlook over the next 12 months is looking up (not down), in Australia, as well as in the USA.

    Adjusting then for inflation, and short-term official rates will, in 12 months time, be higher than what they are today (even if the RBA and the FED go forward with their predicted easings over the next 2 weeks).

    Being the last of its kind in the current cycle, therefore, will bring an entirely new meaning to the concept of 4.99% fixed "honeymoon" rates. It will, therefore, be interesting to see whether the banking and finance statistics for 3Q03 point to a growing trend in fixed, vs variable borrowings (ie: increasing bias towards fixed).
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