Saving grace for the Reserve Bank: Secret Agent
GUEST OBSERVER
There are two ways to be a consistent winner in investment: information asymmetry (mostly through insider trading, which is illegal) and holding assets in the long term. Both of these methods are protected from short-term volatility.
The first expects and profits from these movements (often very risky as all public information is already factored in the price), while the latter can safely ignore the daily peaks and troughs, knowing that these will cancel out over a longer period of time.
Investing for long-term returns and robustness is the appropriate reason to buy treasury bonds, yet it is very counterintuitive for most of us to ignore weekly or monthly yields (even changes over one year can be irrelevant with the right strategy).
Business Insider recently published a story called “The week is underway and Australian bonds are getting destroyed” with an image of a building being demolished. Yet as the article correctly points out, yields are still below pre-Brexit levels (bond yields rise as prices fall), which was less than three months ago. It can be difficult to separate signal and noise from information when there is such an abundance of data.
In our April report on the bond market, the connection between the yield curve (which is a reflection of investor expectations) and changes in the official cash rate was established. A flattening or inverted yield curve almost always leads to interest rate cuts, as the RBA tries to reduce the cost of borrowing. If short-term rates are equal or above long-term rates, there is a disincentive for banks to lend out money.
Looking at the yield curve for August, while the 25-point rate cut at the start of the month has lowered interest rates across the entire range, it has pushed short-term rates below 10- year yields, meaning the curve is no longer fully inverted. This see-saw action (investors lowering long-term expectations, followed by cuts to short-term rates) can be clearly seen in Figure 1 above.
In the past few weeks there has been some saving grace for the reserve bank. Investors have improved their long-term outlook, pushing bond yields up and prices down. This makes another rate cut in the next few months unlikely.
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