Australian bonds witness heavy sell-off ahead of next week’s FOMC decision; Fed rate hike seems inevitable

The Australian government bonds witnessed a heavy sell-off on last day of the week as investors await the Federal Reserve’s next week monetary policy decision.

The yield on the benchmark 10-year Treasury note, which moves inversely to its price, rose 8-1/2 basis points to 2.83 percent, the yield on 15-year note jumped 9 basis points to 3.29 percent and the yield on short-term 2-year bounced 3-1/2 basis points to 1.86 percent by 04:40 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% at its policy meeting on 14th December. 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.

On Wednesday, the third-quarter GDP fell 0.5 percent q/q, registering the first biggest decline since global financial crises, from up 0.6 percent q/q in the previous quarter. The market had expected GDP to rise 0.3 percent. Additionally, yearly data rose 1.8 percent y/y, way lower than the market consensus of 2.2 percent y/y gain, from prior 3.3 percent.

Although the Australian economy contracted by 0.5 percent in the third quarter, this is very unlikely to be the start of a recession as GDP will most probably rebound in the fourth quarter. Nonetheless, this is only the fourth fall in GDP in 25 years, which highlights that the economic backdrop is not consistent with a big rise in underlying inflation, said Capital Economics in its research note.

Moreover, the Reserve Bank of Australia in its last monetary policy statement for 2016 left its benchmark interest rate steady at 1.50 percent after cutting twice in May and August. Also, the central bank in its monetary policy statement noted that steady policy rate is consistent with economic growth, inflation targets and global economy growing at lower than average pace.

Further, the central bank noted that the world’s second-largest economy has steadied and economic conditions in China supported by growth in infrastructure and property construction but medium-term risks remain. Also, mentioned that home prices rising briskly in some markets and global outlook for inflation more balanced than "for some time".

Meanwhile, the benchmark Australia's S&P/ASX 200 index traded 0.16 percent higher at 5,566 by 04:40 GMT. While at 04:00 GMT, the FxWirePro's Hourly Australian Dollar Strength Index stood neutral at +38.92 (higher than +75 represents bullish trend).