RBA meeting

For the first time in a while, stock investors are eyeing the bond market with caution following some sharp moves in yields last week.

Australia’s quarterly CPI print on Wednesday showed a key measure of core inflation rose higher than expected.

In response, bond markets immediately put selling pressure on shorter-term bonds as yields rose sharply.

What followed was the main story on markets last week; the RBA chose not to step in and buy three-year government debt; instead letting market forces play out.

The three-year was in focus because that’s where the RBA has maintained a yield curve control (YCC) program to effectively ‘cap’ the yield near the benchmark cash rate.

Three-year yields promptly shot higher. And for CBA economist Stephen Wu, the central bank’s decision means “we can only assume that at Tuesday’s Board meeting this target will be abandoned”.

So while the equine racers storm around Flemington, a crucial post-COVID RBA meeting will take place when the central banks holds court at 2:30pm AEST.

Where to next?

To this point, equity markets have comfortably digested the prospect of tighter monetary policy, as stocks climb to new all-time highs.

But any unexpected changes in the pace of that policy tightening still has the capacity to create volatility.

If the RBA does formally abandon its YCC program this afternoon, that raises a conundrum on interest rates.

So far, the bank has held firm to its view that rates won’t rise until 2024.

But if it stops targeting yields three-year government bonds (i.e. 2024), it will most likely have to communicate a change of strategy in its rate-hike timeline.

Markets are so far staying aggressive, pricing in a rates move early next year.

CBA doesn’t expect the RBA and match the market in its forecasts. Here’s what Wu says to watch for:

“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,” he said.

In terms of the rates outlook, Westpac chief economist Bill Evans weighed in last Friday, with a more dovish forecast than what the market is currently pricing.

The March quarter of 2023 is the date range to watch, he said.

More specifically, “the February 1 Board meeting being the most likely timing when rates will start rising”.

So in Evans’ view, there’s still a year and change until rates actually get on the move.

But like Wu, he’s on the lookout for the RBA to communicate that it is staying nimble regarding its response to Australia’s post-COVID emergence.

In fact, Evans would “strongly applaud” a shift in tone by RBA governor Philip Lowe. Effectively, a dialling back of the ‘whatever it takes’ approach that helped buffer the financial system from the pandemic disruption.

“Success is now likely to come earlier than expected and a cautious recognition of that prospect would be welcome,” Evans said.