Summary:
Just as we noted previously, directionally, Australian bond yields have since the beginning of the year being set by the direction of the US bond market. And that means the 10-year government bond has had its best month since July 2024 as yields fell all week. The 10-year declined 17 basis points over the week. It is off almost 30 basis points since its January 13 recent high. The 2-year, 12 basis points, pricing in 3.77% versus the current cash rate of 4.1%.
So, notwithstanding the yield volatility of late, bonds have been exhibiting negative correlation to equities, and has generally been doing so for six months. This is significant – the inverse correlation not only broke down from early 2003 but went wildly positive.
A report released on Thursday showed that business investment in Australia unexpectedly declined in the fourth quarter, indicating a slight drag on economic growth and adding to case for more policy easing. Meanwhile, data on Wednesday showed headline inflation held at an annual 2.5% in January, while core inflation ticked up to 2.8%.
While this report does not provide definitive signal for further rate cuts, it offers reassurance that inflation is trending in the right direction and supports the Reserve Bank of Australia’s recent rate cut. However, RBA Deputy Governor Andrew Hauser said on Thursday that the central bank would need to see further progress in inflation before considering additional rate cuts.
But as noted earlier, the direction of domestic bond yields is really being set by the US market. Forget the actual data, it’s the slew of negative consumer sentiment / expectations surveys over the last three weeks that is really setting the tone – declining yields (rising bond prices), a very nervous equities market.
Take Friday as an example. The yield on the 10-year US Treasury note was at the 4.25% level on Friday, plunging over 15bps in the week to its lowest in over two months as markets assessed the latest economic data against concerns that US tariffs and aggressive government spending cuts will hurt growth in the world’s largest economy. Personal spending in the US unexpectedly slipped in January 2025 while income soared. Additionally, headline and core PCE price indices edged higher as expected, maintaining market bets that the Federal Reserve may cut rates only twice this year.
Bets on rate cuts increase this week with short term spreads widening slightly (see chart below). In terms of the chart, the overnight indexed swap spread is the difference between the interest rate on long-term overnight indexed swaps (3-Month OIS Rate) and 1-month overnight indexed swaps.
Bank bill swap rates fell back this week.
| TERM TO MATURITY | CLOSING RATE | Δ WEEK | Δ MONTH |
|---|---|---|---|
| 1 month | 4.195 | -0.027 | -0.125 |
| 3 months | 4.204 | -0.006 | -0.136 |
| 6 months | 4.28 | 0.013 | -0.16 |
Swap rates increased across the curve, somewhat outpacing the rises of their Commonwealth Government counterparts.
SWAP RATES
| TERM TO MATURITY | CLOSING RATE | Δ WEEK | Δ MONTH |
|---|---|---|---|
| 1 year | 3.844 | -0.044 | -0.209 |
| 3 years | 3.683 | -0.143 | -0.216 |
| 5 years | 3.953 | 0.01 | -0.227 |
| 10 years | 4.257 | -0.161 | -0.204 |
| 15 years | 4.418 | -0.204 | -0.202 |
As a result, swap spreads generally widened moderately. By the end of the week, the 3-year spread had gained 6bps to 2bps, the 5-year spread had inched up 1bp to 15bps while the 10-year spread finished 5bps wider at 9bps.
AU and US Bond Yields Spread
What the chart below highlights is just how much the Australian bond market is tracking and mirroring the US market. And that also means the Australian bond market has been exhibiting a high degree of volatility since the start of the year. In fact, bond volatility has been materially higher than equities volatility.
This week we examine the relative safe haven corporate bonds has become versus sovereign debt.
Exhibit 2: AU and US Bond Yields Spread
