Summary:
Whipsaw is the key word for describing the US bond market last week. The yield on the 10-year rose all week long, driven by Wednesday’s hotter than expected US CPI print, only to decline 20 basis points on Friday following the weakest retail sales data in 2 years (we note large weather effects). In fact, the bond market has exhibited more volatility than US equities since the beginning of CY25.
The CPI data on Wednesday was ever so significant. It dashed expectations of a cut this year – with the market now pricing in one cut in December this year. The 2-year bond is now pricing out a cut. More importantly, the chat with clients has what last week was perceived as inconceivable – the possibility that the next move by the Fed will be an increase. To be clear, no one in the market is expecting this currently, but what was the inconceivable has become the conceivable.
And expectations matter for asset pricing. The Fed has been able to convince the market on the safe landing narrative to this week. That is now out the window. Legitimate criticism has been directed to the Fed that, following their monster 50 basis point cut last year, they lack interest rate policy strategic direction. Nothing looks worse than a resurgence of inflation after rate cuts.
And this matters regarding the RBA and Wednesday’s decision. If you are not viewing the US CPI print and market reactions as a shot across the RBA bow, then you are not watching. We note the Australian market repriced Wednesday’s cut from 95% to 90%, arguably not enough. We acknowledge that the interest rate transmission dynamic is different in Australia (no one is on low rate 30-year mortgages in Australia), but the US CPI print would rightly have sent a chilling message to the RBA. Tuesdays’ decision will be the biggest decision it makes this year, financially and, of course, politically.
What is not chilling is the ongoing excess demand for Australian government and corporate bond issuance, with record degrees of over-subscription. There are relative yield and technical issues at play here. Here’s a factoid that was noted to J Powell this week during his semi-annual testimonies – the US government issues as much debt in a week as Australia’s current annual budget deficit. This is a part technical and relative yield story. Anyways, the consequence is that spreads remain exceptionally tight – this is a watch this space risk (widening spreads) but, to be honest, it is hard to see a near term catalyst for a widening currently – corporate Australia and America is looking solid.
