The bond market’s China warning for Australia

The bond market's China warning for Australia

The Bank of England, which also held its first meeting of the year this week, noted in its minutes how asset prices had “responded significantly” to the coronavirus crisis.

Arguably the most significant response was in the bond market, where doom equals boom.

The threat of a hit to global growth fueled a sharp drop in yields, with bond prices rising as investors sought the perceived safety of fixed income assets.

The scramble for safety drove the yield on Australia’s 10-year bond below 1 per cent for the first time since October, when fears of a global recession caused by the US-China trade war loomed large.

The drop down into double-digit territory – the yield was around 96 basis points on Friday – is well below the 1.37 per cent at the start of the year, when investors sold bonds and bought stocks on hopes the end to the US-China trade war would lift economic and earnings growth.

Yield curve flattened

Another indicator of heightened concern about the possible impact on Australia’s growth was the flattening of the yield curve.

The yield curve – defined as the difference in yields on a two-year bond and 10-year bond – typically points up and to the right when bond traders have an upbeat view on the economy.

So the flattening of the curve from 44 basis points at the start of the year to a low of 27 basis points this week telegraphs some angst that Australia’s growth may not be as rosy as investors had expected earlier this year.

That the yield curve still has some steepness in part reflects the generally better economic data (albeit historic) since the start of the year.

A nine-month low in the unemployment rate and stronger-than-expected headline inflation have cruelled hopes for an interest rate cut next week.

All of the big four banks have abandoned their call for a rate cut on February 4, with April now the consensus timing of the first easing of 2020. The RBA meets on April 7, a month after the release of fourth-quarter growth data on March 4.

Rates traders disagree. While the spectre of a China slowdown has seen the pricing of a full rate cut move in from August, current betting is on the RBA pulling the trigger in June.

But rates traders and economists are agreed that more stimulus is needed. Wary consumers have weighed on growth in Australia because of low wages growth and high household debt.

But already economists are estimating the coronavirus outbreak could wipe 0.2 of a percentage point off GDP in the first quarter of this year.

While incoming data is looking more positive, bond traders – who get paid to look over the horizon – are a little wary about the durability of stronger data should growth be felled by the coronavirus.

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