RBA watching is one of the market’s favourite past times.
When and what the RBA does next remains to be seen. It might be a good time for a reminder about what central bank interest announcements can and cannot tell us about the future of yields in fixed interest markets.
Some investors may be tempted to make duration decisions within their bond allocations because they assume other interest rates will follow any RBA cash rate movements.
However, it is not a given that the whole yield curve would move in lockstep with any RBA rate cuts.
As an illustration, let’s look at the market reaction to recent policy rate cuts by both the Bank of Canada (BOC) and the European Central Bank (ECB).
Each cut rates by 0.25%, the first changes since the last of their rate hikes in 2023. The exhibit below shows the yield curves the day prior to the central banks’ moves and the curves at the close of the day of the rate cut.
As you can see, the markets’ response was relatively muted.
That is because yields reflect market participants’ aggregate expectations, including how and when central banks will act. In this case, the rate cuts had been heavily telegraphed to the market, and bond prices reflected that expectation.
But it’s more complicated than tracking central banks.
Many factors influence yield curves, such as data on inflation, geopolitical risk, GDP growth, trade data, and other economic indicators, as well as bond supply, and investor expectations.
That’s why interest rate predictions are so challenging! As a case in point, the sovereign curves of Canada and Germany moved in opposite directions in response to similar policy decisions.
This means that even if you could successfully predict the timing and direction of RBA moves, you would not necessarily know how broader interest rate markets would react.
The lessons are familiar. Rather than attempting to time these changes in interest rates, investors are better served making bond allocation decisions based on long-term goals rather than short-term predictions, while managing risk via global diversification across many yield curves.
EXHIBIT 1
Policy Rate Cuts by the BOC and ECB in June 2024
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