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Are rate hikes around the corner?
Mitrade Team
2021-01-28 920

If you believe the bond and the swaps markets, inflation is imminent that rates are going to change faster than forecasted and that several rate hikes are likely in 2021.


We have discussed, at length, the reasons that this won’t happen. The US is case-in-point as the Federal Reserve needs core inflation to ‘average’ 2% in core PCE before it will even consider raising rates – the reasoning is that so it can look through short bouts of inflation like what has been seen now. In fact, Vice Chair Richard Clarida had gone further on this point insisting that ‘average’ in the current environment means a ’12-month’ average at 2%.


As we know, US PCE is miles off averaging 2% on a 12-month basis – but that hasn’t stopped the bond market pricing in some risk that rates will rise this year. The US 10 year for example is holding above 1.1% which is interesting to say the least and it is certainly making the headlines for all the wrong reason as the Fed wants the rate back below 1% and that might mean it will possibly intervene.


It’s not just the US that is facing this same pressure – Australia too is seeing ‘inflation talk’ as a driver of the FX, swaps and bond markets. The catch is like the US – the headlines are missing the point, and yes inflation is coming, but it’s from a very low base and that most of the rapid increase in inflation is due to COVID-decimated sectors returning to baseline.


If we look at the fourth quarter consumer price index in Australia that came out in this week’s headline, core inflation beats expectations across the board with headline CPI at 0.9% for both quarter-on-quarter and year-on-year, on the core inflation (trimmed mean) it was 0.4% QoQ and 1.2% YoY.


The biggest driver of this was tobacco going up over 10% while childcare returned to pre-COVID levels, one of the largest detractors of inflation last year as the Australian government looked to subside childcare for all. Things like ‘urban transport fares’ jumped 4.5% as more people return to work in the office, which is a trend that will continue.


However, the clear take-out from the inflation data is that the rises are unlikely to be sustained, and a stronger pulse will be needed to reach target - something the RBA is fully aware of.


Secondly, under the RBA’s mandate on inflation, core CPI needs to be 2% to 3% band for the rates to rise. That is not something that will be achieved in 2021 and thus rates in Australia also are not going to rise anytime soon.


But like its US peer, the Australian 10 year has pushed higher over the past few weeks and expectations of a rate rise have grown, admittedly from a very low base. FX too has started to consider rate rises, with AUD easing on the headline data and the theory inflation will materialise.


But as we have just explained, the headline reactions are missing the medium-term view - that rates are likely to be fixed at current levels for all of 2021 and probably beyond, and an FX reaction opposite to this idea is an opportunity to be considered.


This information has been prepared by Mitrade. In addition to the disclaimer below, Mitrade does not represent that the information provided here is accurate, current or complete, and therefore should not be relied upon as such. This information does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. Mitrade is not a financial advisor and all services are provided on an execution only basis. We advise any readers of this content to seek their own advice. Reproduction or redistribution of this information is not permitted.


Derivatives trading involves risks and the above information is not suitable for everyone. Refer to our PDS and ensure you understand the risks involved.


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