Australian bonds plunge as rally in energy prices boost inflation expectations; Fed rate hike hopes support

The Australian government bonds witnessed a heavy sell-off Monday as investors moved away from safe-haven buying amid rising crude oil prices that lifted inflation expectations.

Also, investors await the Federal Reserve’s last monetary policy decision for 2016 scheduled to be released on Wednesday by 19:00 GMT.

The yield on the benchmark 10-year Treasury note, which moves inversely to its price, rose nearly 3 basis points to 2.86 percent, the yield on 15-year note jumped 3-1/2 basis points to 3.32 percent and the yield on short-term 2-year bounced nearly 2 basis points to 1.88 percent by 04:50 GMT.

The Australian bonds have been closely following developments in oil markets because of their impact on inflation expectations, which are well below the Reserve Bank of Australia's target. Crude oil prices jumped after OPEC and non-OPEC countries agreed to cut production for the first time since 2001. The International benchmark Brent futures rose 4.16 percent to $56.60 and West Texas Intermediate (WTI) climbed 4.72 percent to $53.93 by 04:50 GMT.

The Federal Reserve is expected to increase the target range of the key interest rate by 25 basis points to 0.50 percent to 0.75 percent, with a unanimous decision. Little change to the statement, though the Committee is likely to acknowledge that market-based measures of inflation compensation have risen further.

We expect the Fed to raise policy rates by 0.25 percent at its policy meeting on December 14. Such an outcome is unlikely to have much impact as it is already fully discounted in markets. Of more interest now will be what guidance the Fed provides on its intentions for next year. The Fed’s current guidance is relatively cautious with the ‘dot plot’ pointing to two rate hikes in 2017, said Lloyds Bank in its research note.

With the economy seemingly close to ‘full employment’ there is a now a case for more hawkish guidance. The sell-off in US Treasuries reflects concerns looser fiscal policy may cause the Fed to move more aggressively. For now, the Fed will probably not change its rhetoric, while it waits to see what fiscal policy measures are enacted, they added.

Meanwhile, the benchmark Australia's S&P/ASX 200 index traded 0.19 percent higher at 5,522.5 by 04:50 GMT. While at 05:00 GMT, the FxWirePro's Hourly Australian Dollar Strength Index stood neutral at +48.85 (higher than +75 represents bullish trend).