Aussie bond yields have backed up spectacularly in recent weeks. It began with the shift from zero COVID to living with the virus but most of it is the energy crisis that has sent coal and LNG prices to ludicrous levels:
The curve has steepened markedly as well:
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Spreads to the US have flipped positive pressuring AUD higher:
Markets are now pricing the RBA as miles behind the curve. TD Securities:
The market is priced for the RBA to begin hiking in Nov’22 with the strip pricing a 1.25% cash rate by Nov’24 (Figure 1). The market is projecting the RBA and Fed cash rates to rise in lockstep (Figure 2).
While spot RBA OIS tenors have not backed up in yield as much as other spot Central Bank OIS runs in thepast week(Figure 3), the backup in RBA OIS tenors in thepast month(Figure 4, 5yr+) has exceeded the US and matched the more aggressive moves in Canada and UK tenors.
Recent offshore developments cannot be ignored in driving the bearish impulse.However, AUD FI weakness and the rising cost of funding preceded foreignmoves.
The risk is that carry trades positioned for the RBA remaining on hold comeunder continued pressure over coming weeks.
But Mizuho is sobering for bonds bears heading into 2022:
Andrew Bailey, the Bank of England governor, gave an interview to a local newspaper in the UK on 9 October, in which he warned that inflation expectations could become “permanently embedded.” He said pricing in the energy market indicated that inflation would prove to be less transient than the BoE had been predicting. Other senior European and North American central bankers have been voicing similar concerns. A combination of factors is making it harder to dismiss the current rise in inflation as transient. The consensus probably holds that increasingly rapid growth in energy and food prices are “not a long-term phenomenon,” in the words of San Francisco Fed President Mary Daly on the 10th. Equally, the view of Gina Raimondo, the US secretary of commerce, on the8th that “We’re going to be feeling the effects of supply chain disruptions well into 2022,” probably has widespread support.
Here, we consider how long three factors undermining the argument that higher inflation is a transient spike—the semiconductor shortage, surging prices in the natural gas and oil markets, and disruptions to shipping and other supply chains—will drag on for.
1)Semiconductor shortages: auto chip supplies back to normal by Jan–Mar 2022?The term “semiconductor” covers such a broad spectrum of products and applications that it is hard to give a short answer about how long it will take to resolve the ongoing shortage. A large USsmartphone company said it was entirely unaffected by shortages when launching its latest models recently. It is, however, worth reviewing several comments by senior industry officials in Taiwan, a major manufacturing hub, for insights into the shortage of auto chips, which is having a major impact on industrial production and durable goods consumption. Back on 21 August, Reuters quoted Wang Mei-hua, Taiwan’s economy minister, as saying: “Though the automotive chip industry chain is long and complex, with the full cooperation of our country’s firms, the industry estimates that supply and demand for auto chip production should reach a balance in the fourth quarter of this year.”
That timeline appears to have been pushed back since then by rising COVID-19 case numbers in southeast Asia. Reuters provided an update on 1 October, with a report headlined Malaysia’s help needed to ease global chip shortage, Taiwan says. Again quoting Ms. Wang, it reported that “Malaysia’s help is needed to resolve the global shortage of auto semiconductors, especially when it comes to packaging, a sector affected by the country’s COVID-19 curbs.” Ms. Wang said in an interview late on 30 September: “The bottleneck in fact is in southeast Asia, especially Malaysia, because for a while the factories were all shut down. Now the focus is on Malaysia resuming production as soon as possible. I know that Malaysia started to restore production capacity in early September, and now the production capacity has returned to about 80%, so if their capacity can slowly come back, this problem can be slowly dealt with.”
On 8 October, the Nikkei quoted Wong Siew Hai, president of the Malaysia Semiconductor Industry Association, as saying that many chipmakers are returning to full-capacity working to meet the global growth in demand. He explained that the Malaysian government now allows factories to operate at full capacity if more than 80% of the workforce has been vaccinated. This is allowing economic activity to resume rapidly. The onset of winter could bring another wave of COVID-19 infections that further disrupt supply chains, but it does look as if the auto chip shortage will be resolved, maybe as early as this year but definitely by Jan–Mar 2022. Japan’s industrial production statistics show that the index of semiconductor production equipment is at a record high. Economic dynamics are working to resolve the shortage.
2)Surging prices of natural gas and crude oil: the market should fall after the northern hemisphere winter but longer-term factors are also at work. The surging price of natural gas has become a hot topic in Europe. Three factors are involved. First is a longer-term expansion of demand for natural gas as part of the continent’s climate change response (the need to reduce GHG emissions). Second, the Putin administration is pushing for the Nord Stream 2 gas pipeline to enter full service quickly. The pipeline has diplomatic and national security implications for Russia and Europe, since it would increase Europe’s reliance on Russian exports and the new pipeline bypasses Ukraine. Third is the short-term factor of a La Nina weather event, which is expected to bring a colder winter and drive up demand for energy. That should cease to be a factor once spring approaches in Jan–Mar, but the longer-term issue of climate change is set to bolster the price of natural gas (and, as a consequence, crude oil) for years to come, only fading with increased supply and usage of renewables. The timeframe on the Nord Stream 2 approval remains unknown.
3) Disruptions to shipping and other supply chains: hard to predict, but conditions could improve around Jan–Mar 2022. The Baltic Dry Index (BDI), the benchmark price for dry bulk shipping, is at its highest point since September 2008. This is the result of a complex mix of factors, which makes it impossible to say when all will be resolved. However, we suspect to see major improvement around Jan–Mar 2022. Jiji Press reported on 6 October that the BDI is at a 13-year high and that the pandemic has caused delays at processing facilities. The article contained a detailed description of the situation, as did the Nikkei on the 9th, in a report that linked rising demand for coal transport to the rise in large charter rates. The Nikkei noted that the Capesize spot rate is at a 12-year high. The Jiji article noted that the stepped-up pandemic response has led to delays in onshore freight processing in China, the world’s largest importer, and elsewhere. These disruptions have created supply-side bottlenecks and driven up prices. Buoyant demand in China has led to increases in the major dry bulk shipping indices. In addition, the hurricane that made landfall in the US in late August damaged export facilities and forced the suspension of shipments from major ports.
Stricter COVID-safe measures at ports around the world have made it harder to source enough workers and replace crews, creating frequent delays in transferring cargos to shore and other logistics operations. It reported that one Australian shipping company is now taking 14 days to sail to China, unload, and return. This is causing backlogs of ships in many Australian ports. When ships are forced to anchor at sea because they cannot enter port, it reduces the number of vessels able to supply the market and means ports are operating below capacity. This all forces up prices.It is clear that the future course of the pandemic will have a major bearing on this. Australia has pivoted to living with COVID and is starting to ease restrictions, while the Chinese authorities continue to pursue an elimination strategy. We shall need to keep a close watch on the various factors stoking the inflation fears that have become such a dominant market theme. This is set to remain an issue throughout the rest of this year and into next.
In my view, the RBA is not going to move before 2024 and probably not then, either. Ahead is:
- China property bust and energy crash in LNG, thermal and coking coal plus deeper falls for iron ore.
- Income shock for Australia in 2022 just as macroprudential tightening hits the property market.
- Floods of immigration to smash wages the moment the border opens.
We may well see more QE before we see any RBA tightening.
At 1.75%, Aussie long bonds look attractive.