Rates Markets Are Watching RBA for Signs of an Early May Hike

(Bloomberg) -- Bond investors will be scrutinizing Tuesday's Reserve Bank of Australia meeting for any signs policy makers will start their tightening cycle next month rather than wait until June.

The odds of a hike in May have oscillated wildly in recent weeks, with futures now indicating the outcome is a coin toss, down from a more-than 70% probability just a week ago. They have been as low as 27% this year and as high as 140% -- the latter signifying the chance of more than just one increase.

The danger for Australian bond holders is central bank Governor Philip Lowe backs away from his recent “patient” stance and suggests there's a need to bring forward tightening due to factor such as improving local data, the hawkish tendency of his global peers and the inflationary impact of the war in Ukraine. The RBA hasn't raised rates since November 2010 and any shift in view may lead to a selloff.

“We will be watching for any shift in the ‘patient' language or new language suggesting that emergency cash settings of 0.1% are no longer appropriate,” said Su-Lin Ong, head of Australian economic and fixed-income strategy at Royal Bank of Canada in Sydney. “An acknowledgment of any of the key developments that argue for higher rates is likely, and that means the market will keep pricing in some risk of liftoff as early as May.”

Ong said three key developments over the past month argue for a change in RBA rhetoric: the way global central banks such as the Fed look set to tighten more aggressively, robust Australian labor-market and retail-sales data, and a pump-priming pre-election budget handed down at the end of March.

Bond Losses

Australia's bonds have tumbled 5.9% this year, extending declines in recent weeks even as traders trimmed bets on an RBA move in May. Markets are certain the central bank will keep its benchmark at a record-low 0.1% Tuesday. They are also fully pricing in at least one hike by June to take it to 0.25% -- followed by six-straight increases in the second half to raise the benchmark to 1.75% by year-end.

Bonds globally suffered their worst quarter on record in the three months through March due to soaring inflation and expectation that central banks would hike rates aggressively to bring it under control. Australia's debt also fell out of favor as the economy is seen benefiting from higher prices for the raw materials it exports such as iron ore, wheat and coal.

Those factors increased the extra yield investors demand to hold Australian 10-year bonds over similar-maturity Treasuries, with the premium widening by 33 basis points in the first quarter to reach 49 basis points on Thursday, the most since 2017. They have also helped make the Australian dollar the best-performing Group-of-10 currency this year, with a gain of more than 3%.

Australia's three-year yields jumped by more than 140 basis points in the first three months of 2022. That's second only to the 147 basis-point surge in the first quarter of 1994, according to data compiled by Bloomberg going back to 1990.