The thing to remember when you see reports that the US Federal Reserve’s monetary tightening and interbank money supply difficulties in the Chinese economy are forcing up Australian government bond yields is that the Australian government bond market doesn’t actually matter that much.
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Bond markets everywhere reprice yields in an environment where rates are expected to rise, and do so by lowering the price of bonds on issue. This boosts the yield on issued bonds in the same way that paying less for a share that pays dividends boosts the dividend yield in the hands of the new owner.

In the US, rising long-term government yields feed directly into economic activity because they are the pricing benchmark for other key debt products, including most of America’s stock of housing debt. Mortgage rates are rising in America in tandem with rising US bond yields, and as I reported on Saturday, one of the market concerns is that this will squash America’s economic recovery.

But while 10-year US government yields have risen by 40 basis points in a week on the back of the Fed’s timetable for a reversal of quantitative easing, they are still objectively low, at 2.54 per cent.

If the Fed is right and the US economic recovery is becoming more robust, the system should be able to handle yields that high, and higher borrowing costs in other US markets including the recovering housing market that flow from them.

Remember too that Fed chairman Ben Bernanke says that if the economy does stumble under the weight, the pace of QE’s retreat will slow. QE could even expand if the American economy tanks again.

Bond yields have jumped around the world on the Fed’s announcements, including in Australia. Commonwealth 10-year bond yields snuck above 4 per cent on Monday, more than half a per cent higher than they were before Bernanke disclosed the provisional QE retraction timetable on Wednesday last week, US time.

They were slightly lower on Tuesday morning at about 3.98 per cent, but the key point is that in this market, Commonwealth bonds tend to trade in majestic isolation. Nothing much prices off them at all.

Mortgage and business rate loans are almost all variable rate money, and they are influenced by bank deposit costs, wholesale borrowings costs and short-term financing rates including the Reserve Bank’s cash rate.

The Reserve’s cash rate is set at 2.75 per cent at least until the Reserve board holds it monthly meeting next Tuesday.

Short term swap rates in this market also do not signal a worrying credit squeeze. A key marker, the overnight indexed swap rate, has only risen from around 2.6 per cent to 2.665 per cent since the Fed announcements – and at that level is still below the Reserve’s own cash rate of 2.75 per cent. The markets in other words are still pricing in some chance of another cash rate easing.

Higher bond yields here do imply higher borrowing costs for the Commonwealth government. It has to meet the higher Commonwealth bond market yields when it finances itself with new borrowings.

The rise is not cataclysmic so far, however, and Australia’s government debt levels are relatively low by world standards, even after the spending that occurred to bolster the economy during the financial crisis.

The big debt load is held by Australian households, and most of it is mortgage debt that so far isn’t significantly affected by the Fed Frenzy.

The original release of this article first appeared on the website of Hangzhou Night Net.

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