To Hike or not to Hike? Now that is the question.

But yield curves are not only a reflection of interest rates – the yield on bonds is driven by supply and demand dynamics, which take into account estimates of future economic activity, that includes a collective view of future cash rates but also encompasses views on national productivity, unemployment and inflation.

Importantly, bonds are also seen as a safe haven asset. Some see the collapse of Credit Suisse and the US banks as a precursor to a global recession, and this is where the flight to safety comes in, driving a greater demand for bonds, which pushes yields lower.

Inflation is easing – but not fast enough

Despite the large and sudden drop in bond yields, the Federal Reserve in the US pressed ahead with another 25 bps at their most recent meeting on March 22^nd, setting a new target range of 4.75% to 5%, the highest level since 2007. While most economists predicted this latest rate rise by the Fed, it still surprised many. US inflation eased in February but remained stubbornly high, presenting a challenge for the Federal Reserve as it confronts how to slow the economy with higher interest rates while not sending it into recession.

The RBA now face the same challenge - have they done enough to slow the economy and bring inflation back down to their target band or 2% - 3% or do they need to keep raising rates and risk sending the economy into recession.

So will the RBA keep raising rates or are we done for this cycle?

But while inflation is slowing both here and in the US, it isn’t going away as quickly as many may have hoped. Federal Reserve officials have continued to beat the drum on their aggressive inflation fight, saying the central bank will keep hiking interest rates until it’s under control.

The issues are the same for Reserve Bank of Australia. Market pricing for RBA’s terminal rate has moved considerably. But the solid underlying momentum in the economy, as evidenced by the robust business conditions and stable labour market, suggests further tightening may be needed.

The RBA may indeed pause rate rises at its April meeting, or it may follow the US with another 25bps increase. We will find out on April 4^th at 2:30pm (AEST). While another hike will be hard for those with mortgages and continue to put pressure on the housing market, the cost of living will only reduce as inflation comes down to the RBA’s target band.

The positive news for investors is that inflation is moving in the right direction, and we expect that interest rates are now very close to their “terminal rate” for this cycle.

 [1] Yields and prices are inversely related, so falling yields on bonds means that bond prices are increasing, and rising yields means that bond prices are falling.

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