Revisiting Our Interest Rate Views

BMI View: Although recent decisions from monetary authorities and governments around the world have benefited some segments of the Australian economy and its financial assets, we believe that the country's own economic woes will pressure the Reserve Bank of Australia (RBA) to lower its benchmark rate by another 25 basis points to 2.25% by end-2013. Moreover, we maintain that Australia will see a period of subdued economic growth due to the ongoing rebalancing process and, thus, we believe that there is value in the long-end of the Australian yield curve, with scope for the spread between the two and 10-year bonds to narrow.

Recent decisions by the US Federal Reserve and other authorities around the world have benefited some segments of the Australian economy as well as its financial assets in recent weeks. While structural deficiencies in the domestic economy has not been eradicated, we see a growing risk that monetary authorities could take their foot off the easing lever in the near term, but highlight that this is likely to translate to more aggressive easing in 2014.

Short-Term Rates: Maintaining Our Call For Another Cut Despite Growing Risks

How Long Will The Uptick Last?
China Purchasing Managers Index (LHS) & AUD 9X12-Month Forward Rate Agreement (%)

BMI View: Although recent decisions from monetary authorities and governments around the world have benefited some segments of the Australian economy and its financial assets, we believe that the country's own economic woes will pressure the Reserve Bank of Australia (RBA) to lower its benchmark rate by another 25 basis points to 2.25% by end-2013. Moreover, we maintain that Australia will see a period of subdued economic growth due to the ongoing rebalancing process and, thus, we believe that there is value in the long-end of the Australian yield curve, with scope for the spread between the two and 10-year bonds to narrow.

Recent decisions by the US Federal Reserve and other authorities around the world have benefited some segments of the Australian economy as well as its financial assets in recent weeks. While structural deficiencies in the domestic economy has not been eradicated, we see a growing risk that monetary authorities could take their foot off the easing lever in the near term, but highlight that this is likely to translate to more aggressive easing in 2014.

How Long Will The Uptick Last?
China Purchasing Managers Index (LHS) & AUD 9X12-Month Forward Rate Agreement (%)

Short-Term Rates: Maintaining Our Call For Another Cut Despite Growing Risks

Current indications from the forward rate agreeme nt market for the Australian dollar suggest that there are risks to view for the Reserve Bank of Australia (RBA) to deliver another 25 basis points worth of cuts by year-end. Moreover, Chinese stimulus , together with another increase in total social financing (i.e. easing monetary conditions) , have led to improvements in China's economy reflected by the improv ed readings of the p urchasing m anagers i ndex and stabilising import growth . This could mean some respite for the Australian economy for the next few months.

Despite the growing risks to our interest rates view which have been primarily driven by external forces, data within the Australian economy suggests that businesses are increasingly unwilling to spend, with hiring intentions falling to the lowest level since 2009 and business credit growth stubbornly hovering around 0.0-1.0% year-on-year (y-o-y). The decision by the US Federal Reserve to maintain its quantitative easing programme for now may also help convince the RBA to deliver another rate cut in an effort to reduce the appreciatory pressures on the Australian dollar and provide some relief to exporters.

Moreover, with the central bank gradually appearing more open to the use of macro-prudential tools , together with regulatory authorities at home and abroad (IMF) increasingly monitoring household debt and the housing market, we see a growing possibility that the RBA could use these rules to afford itself greater flexibility to lower rates while limiting positive spillovers on house prices. Thus, we maintain our outlook for the RBA to deliver another 25 basis points by the end-2013, bringing its cash rate to an all-time low of 2.25%.

Convergence In The Pipeline
Australia - 2 & 10-Year Government Bond (% Yield) & Spread (bps)

Long-Term Rates: Long-End Likely To Come In

With regards to the longer- term outlook for rates, we maintain our view that Australia's ongoing structural problems will not be fixed by easing monetary conditions or increasing stimulus and, as such, we believe that economic growth will remain subdued while the rebalancing process is underway. Our view for a period of slower growth in the Chinese economy will also weigh on Australia's export fortunes as it itself undergoes a much-needed restructuring process. As such, we believe the period of low interest rates will persist for longer, forecasting the benchmark rate to remain below 3.0% for the next five years. As such, we believe that there is some value in longer-dated Australian bonds , given that 10-year notes participated in the recent global yield run-up despite domestic woes. With the country's own economic situation likely to come to the fore, we believe that the spread between the two and 10-year yields, currently near 2009 levels, is likely to narrow over the next few months.

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Sector: Country Risk
Geography: Australia
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