What happened to lower for longer interest rates?


Interest rates have suddenly started moving higher again, at least in bond markets.

Sure, the US Fed is embarking on an ultra-modest lift in its cash rate from close to zero to less than 1% in the year ahead, but everywhere else - including Australia - policy rates are seen flat to falling.

Yet the yield on US 10-year bonds have jumped over 0.5% since the US election, and are up 1% to 2.3%, from their mid-year low.

This has been broadly mirrored in Australia, where 10-year bonds have risen from around 1.8% to 2.7%.

So what happened to lower for longer? There's still plenty of evidence that trend growth has fallen across the advanced and developing world post the global financial crisis.

And this should mean growth, inflation and interest rates remain noticeably lower than during the previous couple of decades. But the key issue is whether this lower 'new normal' is quite as low as where things have been over the past year.

If not, it could mean yields have a little further to correct before things stabilise.

There have been three drivers of the recent yield sell-off.

Firstly, while there have been plenty of risks to negotiate and the outlook is uncertain, recent signs of steadying global growth, along with rising commodity prices including oil, suggest risks of global deflation have been dissipating.

Secondly, reflecting this, global central bankers have been shifting from telling markets they'll do "whatever it takes" as far as easing policy, to suggesting they've given us everything they've got.

Finally, reinforcing these modestly rising inflation pressures, the unanticipated US-election result has forced the market to focus on the President-elect's plans for tax cuts and new infrastructure spending that likely adds to growth and inflation, but is also unfunded adding to debt.

While negative shocks could see bond yields rally lower again, for now, their sell-off is having broad market impacts, from capital loss for bond bulls through to sharp under-performance for shares that are bond proxies, of which there are many in the Australian market.

For Australian property, the renewed 'reflation' tone globally likely means the RBA will not need to lower official interest rates again.

Rising bond yields will translate into a drift up in fixed term home loan rates ahead, reversing modestly their support for housing demand over recent years.

With fixed rates likely to drift back toward (or even above) discounted variable rates, this will also make the decision between fixing and floating that much more difficult for borrowers.

Scott Haslem is chief economist and head of macro research with UBS Australia and New Zealand.


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