Could interest rates in Australia fall after the collapse of two US banks?

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Tuesday was an extraordinary day for bond market traders as they witnessed extreme price movements — and this matters for millions of Australians because the price movements reflect where interest rates are heading.

“Bond market moves have been very powerful over the last few days,” Angus Coote, co-founder and head of investments at Jamieson Coote Bonds, told the ABC.

“We have seen a flight to buy high-quality government-backed bonds both in Australia and offshore markets, as investors move away from riskier-type assets — which is typical in stressful periods.”

Over the past 24 hours, short-term bond prices (IOUs between banks over days and months) in Australian and international debt markets have surged, and yields (interest rates) have plunged.

The yield on two-year US Treasuries fell almost 60 basis points (0.6 percentage points) at one point in overnight trade (Australian time) to just over 4 per cent.

The yield has now dropped a full percentage point since the middle of last week.

What does this drop in interest rates on bonds mean?

Analysts say the market drop in the interest rates on bonds is on par with what occurred after the “Black Monday” share market crash in October 1987.

The growing fear in financial markets relates to unease about the health of thousands of mid-tier banks in the US.

Late last week, news dropped that Silicon Valley Bank (SVB) was insolvent.

SVB endured the early stages of a classic bank run where an overwhelming number of customers went to withdraw more cash than the bank had available for them.

At the heart of the bank’s problems is an aggressive interest rate hiking cycle from the US Federal Reserve as it attempts to contain and reduce soaring inflation.

While larger US banks are said to remain healthy, there are question marks about the solvency of thousands of regional US banks.

On Sunday, Signature Bank also shut its doors, unable to supply customers’ deposits.

The thinking in financial markets now is that on top of the measures US and British regulators have already set in place, the US Federal Reserve will be forced to pause its current interest rate hiking cycle to ease the pressure on the entire US banking sector.

“With financial stability concerns moving to the forefront, we adjust our call to assume no hike at the upcoming FOMC [Federal Open Market Committee] meeting, justified by risk management considerations,” Barclays bank said in a note.

Will the Reserve Bank end interest rate hikes?

The international money markets are looking further ahead and are pricing in an almost full percentage point cut to US interest rates by the end of the year.

Sentiment on interest rate movements has also shifted in Australia.

Money markets on Tuesday assumed the Reserve Bank will pause its interest rate tightening cycle next month — with a small 7 per cent chance they may cut the cash rate by 0.25 percentage points.

Looking further ahead, NAB’s chief economist Alan Oster says the Australian financial markets are now betting the RBA will cut the cash rate by 0.25 percentage points by November.

“I think markets are overdoing it,” he said.

But Mr Oster added that if the RBA wanted an excuse to pause its current interest rate hiking cycle, the economic uncertainty produced by the collapse of the Silicon Valley Bank “just gave it to them”.

However, AMP’s chief economist Shane Oliver does not believe the interest rate landscape has changed either in the US or in Australia.

He says the focus for central banks will remain squarely on taming inflation.

“At this point, it’s not clear that we are seeing a full-blown crisis unfold or not and high inflation is a bit of a barrier on what the Fed can do,” Mr Oliver explained.

“So far, it’s just gone down the path of making it easier for banks to access cheap funding so they don’t have to sell bonds at a loss.

“But how far the Fed and other central banks can support economies will at least partly be impacted by inflation.”

Similarly, the ANZ Bank remains unchanged in its view on where Australian interest rates are heading.

“We continue to expect the RBA will hike interest rates by 0.25 percentage points in April and May, taking the peak cash rate to 4.10 per cent,” the bank said.

(Original ABC Article)