Shattered Yield Target Sets Stage for Policy Shift in Australia

(Bloomberg) -- The Reserve Bank of Australia left its bond-yield target undefended on Friday, fueling expectations that policy makers will abandon the program as soon as next week.

The rate on the nation’s April 2024 bond note -- which it aims to hold around 0.1% -- soared to eight times that level as investors position for Governor Philip Lowe to beginning winding back his dovish view of inflation.

That would bring him closer to peers like Canada, which ended its bond-buying stimulus on Wednesday, and the U.S., where the Federal Reserve is seen likely to announce a pullback of its debt purchases next week. The Bank of England is also preparing to act on inflation, with some traders wagering on a rate hike at next week’s meeting.

“It is clear that a shift in broader policy settings is underway consistent with a likely more compressed time frame to taper, balance-sheet adjustment and rate hikes,” Su-Lin Ong, head of Australian economic and fixed-income strategy at Royal Bank of Canada, said of the RBA. “Yield-curve control is increasingly past its used-by date.” 

While the RBA stepped in last Friday to purchase April 2024 bonds as markets challenged its outlook, the central bank chose not to repeat this today after data that showed core inflation jumped back inside the bank’s 2-3% target for the first time since 2015.

Yields on Australia’s benchmark three-year bond also extended their advance, surging 14 basis points to 1.26%, poised for the biggest monthly increase since 1994. At the longer end, 10-year yields climbed 24 basis points to 2.08% -- heading for the highest closing level in more than two-and-half years.

“The balance of risks around the RBA has shifted and what really moved the pendulum was the strong inflation print this week,” said Prashant Newnaha, a senior rates strategist at TD Securities in Singapore. He said the central bank is sure to change its forward guidance, which it could shift from the April 2024 bond to April 2023 notes, but that market pricing is for the yield target to be dropped altogether.

Lowe, who has repeatedly pushed back against bets on early rate rises, gathers his policy board on Tuesday to consider monetary settings and the price outlook. Until now he’s maintained that subdued wages growth means there are few obvious alternative sources of ongoing inflation pressure, and conditions for a rate hike are unlikely before 2024.

Swaps traders have brushed this aside and are pricing in rate hikes from next year.

It is doubtful that the RBA could match market pricing for hikes to begin in early 2022. But it could compress the time frame for tapering its longer-dated weekly bond buying -- due to be reviewed in mid-February -- and bring forward expectations for the beginning of a tightening cycle.

“An indication from the RBA that inflation pressures may be building earlier than anticipated and that rate hikes are now likely before 2024 could be expected,” said Stephen Wu at Commonwealth Bank of Australia.

While moves in U.S. Treasuries were subdued in Asia hours Friday, there has been action aplenty this week. 

The curve between 20- and 30-years has inverted for the first time since the U.S. government reintroduced a two-decade maturity in 2020, the latest sign that investors expect central-bank policy tightening to lead to slower economic growth and inflation.

“Australian markets have never had to price an exit from QE before,” said Philip Brown, a strategist at Commonwealth Bank of Australia. “Is this the Australian version of the taper tantrum?”

©2021 Bloomberg L.P.