Debt Markets Sell Off Despite RBA Silence

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1 FINANCIAL MARKET UPDATE Debt Markets Sell Off Despite RBA Silence RBA leaves cash rate unchanged but local debt market sells off anyway Implied yields on 2006 bill futures strip up by between 6 and 20 basis points since their most recent lows late last month Most parts of the yield curve now normal once again Australian dollar higher against faltering US dollar, but Still shaky against other major currencies US debt market in holding pattern ahead of Friday night s payrolls The RBA surprised nobody by leaving the cash rate unchanged this morning, after its Board meeting yesterday. However, the sell-off on the bank bill futures strip that had started with last Friday s upbeat retail turnover report is gathering momentum quickly. Implied Yields on 90-Day Bank Bill Futures and Cash strip: Jun: 5.67 Sep: 5.74 Dec: minus price of most actively traded contract Per Cent Per Annum cash Jan Feb Mar Apr Page 1 of 6

2 It should be noted that the bank bill futures market is paid to jump at shadows - just in case something really is lurking in them. The implied yield on the most actively traded contract has hit its current level (25 basis points over cash) more than once since the RBA last raised the cash rate more than a year ago, but as it turned out the RBA did not validate the futures market s sell-offs. Per Cent Per Annum Impied Yields on Bank Bill Futures Contracts 100 minus price of most actively traded contract... (2) less than 5 months later, the RBA raised the cash rate... twice!!!!!! (1) implied yields dipped as much as 52 basis points below cash in the middle of 2003, but Jan 03 Jul 04 Jul 05 Jul 06 Apr 06 So what is the chance of the RBA following the futures market s lead this time around by raising the cash rate in the next few months? Prior to the next RBA Board meeting, the central bank will have pored over the March quarter CPI (to be published the day after ANZAC Day), while the June quarter inflation report will be available a week or so before the August Board meeting. You would have to say the risk of at least one of those key data releases showing that headline inflation has breached the top of the RBA s 2-3 per cent target is quite high as long as the Australian dollar oil price remains around $90 a barrel, so there is probably something in the futures market s thoughts this time. And that local currency oil price is where it is not only because the US dollar price of WTI crude is closer to $70 than $, but also because the Australian dollar is closer to 70 cents than cents. The local currency recovered overnight against a faltering US dollar, but remains shaky against other major currencies, as narrowing actual and prospective interest rate differentials more than offset still near record high commodity prices. If not for the latter, the Australian dollar would be closer to cents than 70 cents. Page 2 of 6

3 Australian Dollar WTI Spot Oil Price ,2006 Price $A/barrel J F M A M J J A S O N D 06J F M A Index - May 1970 = Australian Dollar Trade-Weighted Index monthly averages Daily, Nov 05 to Apr Nov Dec Jan Feb Mar Apr Jan Mar 06 Page 3 of 6

4 Australian dollar against yen and euro ,2006 yen per $A euro per $A yen euro J F M A M J J A S O N D 06J F M A Index - January 1984 = 100 RBA Index of SDR (a) Commodity Prices and $A$US Exchange Rate note: SDR - IMF special drawing right, multi-lateral currency measure commodities coal and iron ore contract price increases 50 Jan Mar 06 XR Page 4 of 6

5 Australia:US 10-Year Bond Ratio and Exchange Rate ratio $US per $A ratio of 10-year Commonwealth bond yields divided by 10-year US Government bond yields, multiplied by Jan Mar 06 XR ratio Australia:US Cash Rate Differential and Exchange Rate ,2006 Differential (basis points) $US per $A exchange rate is 5-day moving average differential XR J F M A M J J A S O N D 06J F M A 0.7 Page 5 of 6

6 Bill futures and oil price are sourced from Reuters; exchange rates from RBA HBOS Australia Economics Alan Langford (08) Josh Rubin (08) April 2006 No person should rely on the contents of this publication without first obtaining independent advice from a qualified professional person. Except for any statutory liability which cannot be excluded, HBOS Australia Pty. Ltd, its employees and directors will not accept any responsibility for any errors and are not liable for any loss, damage, cost or expense incurred or suffered as a result of relying on any opinion, representations, advice, recommendations, statement or information contained in this publication whether by reason of any negligence, act, omission, default or lack of care and whether or not such loss, damage, cost or expense was reasonably foreseeable. Page 6 of 6