Market Watch

Market Strategist Evan Lucas speculates on central bank motions for the short week ahead.

By ·
31 Mar 2018

This week marks the start of a new month, new quarter and a semi-new conundrum; credit market gaps are turning into chasms.

Being the beginning of the month, it’s central bank time. The Reserve Bank of Australia (RBA) and the European Central Bank meet to discuss cash rates this week. The Reserve Bank of New Zealand, the Bank of England and the US Federal Reserve are due to meet early next week.

None of the mentioned banks are expected to shift their respective cash rates, however, markets are actively doing this on their behalf.

The moves in credit markets will have central bankers diving back into their model and wondering what can be done to mitigate the spill over. The US dollar LIBOR – the benchmark rate for short-term loans – hit 2.29 per cent last Thursday. That’s its highest level since the global financial crisis. It has also registered a record 37 straight day rises.

The credit chasm is being felt globally. Asia, Europe, the Middle East and Australia are seeing spikes in short-dated papers off the back of the LIBOR spike. There is a caveat here; this is not a credit crunch issue like that seen during the European debt crisis that saw cross-nation banks refuse to lend to each other. Instead, it boils down to factors such as mass fund repatriation (likely due to the recent US tax cut changes), huge releases of US T-bills (having seen the US debt ceiling smashed and raised by $US300 billion) and the Federal Reserve of course is raising rates.

However, the concern for central bankers, and let’s concentrate here on the RBA, is that core inflation is struggling to take hold on a more structural basis. A crippling wholesale funding increase due to the chasm in credit markets will lead to a lending slowdown, and that creates funding pressures across the financial services industry. Have a look at what is happening in the US corporate debt market. Investment grade corporate bonds have retched up to 3.86 per cent, the highest level since 2011 – that interest change will need to be covered, meaning less free capital for firms.

Australia’s bank bill swap rate hit 2.032 per cent on Thursday, which is its highest level since February 2016. The RBA will be watching this acutely. Funding changes at this level will put growth, employment and inflation forecasts under pressure. There is a secondary issue here as well – capital outflows.

The Australian 10-year to US 10-year spread is now negative, currently around -20 basis points (bps). This is likely to put the carry trade under pressure, meaning a lower Australian dollar. There has clearly been a sustained and steady decline in the AUD/USD in light of this playing out, something the RBA has championed as it improves net exports. However, the cause of the exodus in the Australian dollar, that being the carry trade, may not be so welcome. It certainly won’t be good for lenders feeling the pinch with more expensive short-dated papers, neither those wanting local funding considering the higher FX costs.

The market is certainly concerned. Cross-currency hedging is now at its highest level in four years. This isn’t isolated to the Australian dollar, but we’re also seeing the hedging trend with the euro and the Japanese yen.

Although there is no chance of a rate movement today, one would expect the RBA to at least acknowledge that a new market paradigm is beginning to filter into Australian domestic markets. The best gauge of how the market reacts to the RBA’s view on credit markets is the 52-week probability of a 25bps hike – this currently stands at 56 per cent, but I suspect it will be lower post the 2.30pm AEDT announcement. 


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