The relentless rise in Australian yields, to levels far beyond anything that the economy will be able to take, is now posing an interesting question. Futures are now pricing a terminal interest rate of 3.7% next year. This would obviously destroy Australian house prices and the economy both:
Sovereign yields are quickly playing catch-up in the single-sharpest and largest repricing in modern history:
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We must ask, then, has Australia in fact lost control of its own interest rates. To put it bluntly, has RBA bumbling triggered an Australian sovereign debt crisis? To wit:
Former Finance deputy secretary Stephen Bartos said during the election campaign there was “competition to lock in as much unnecessary spending as possible”.
“It would seem that both sides of politics have decided the budget bottom line doesn’t really matter because we’re going to be in deficit,” Mr Bartos said.
“As inflation and interest rates rise, governments will start to feel the pinch of higher public debt interest. They will need to turn their mind to how we repair the budget, and just after an election is possibly the time to do things.
“But just a few little adjustments around the edges is not going to make a big difference. The government will need to do significant and serious things, like delay implementation of the next stage of tax cuts until after the budget is back in surplus.”
The Pre-Election Economic and Fiscal Outlook revealed government debt repayments could end up more than $12 billion higher than forecast in the budget if the 10-year bond yield remained about 3 per cent, instead of the projected 2.3 per cent to the middle of this decade.
But now that the yield has hit 3.6 per cent, separate analysis suggests debt could be about $20 billion higher if borrowing costs remain about these levels.
Typically such crises happen when an economy is overextended with foreign debt, often accompanied by twin deficits in the current account and budget. Some kind of shock panics the market and capital outflows send interest rates through the roof.
That is not Australia’s position today while we run large current account surpluses amid historic terms of trade. But we do still have a big foreign debt, big budget deficit, and zero political will to rein it in.
It must also be observed that a lot of the current account surplus is useless to the domestic economy given horribly corrupted tax regimes.
What also normally happens in such crises is that the currency crashes, making the foreign repayments ever more expensive and forming a doom loop.
Again, that is not Australia’s position. Its foreign loans are mostly priced in AUD either directly through sovereign bonds markets or indirectly via bank currency swaps.
But, we can’t fully discount what is going on here as a form of loss of market confidence in Australian macro-management.
The RBA promised yield curve control for another two years. Instead, it was broken by the first feints of market pressure and has clearly lost credibility.
Second, Canberra carpet-baggers look a lot like Trumpian populists. They show no care for budget repair amid an inflation and interest rate breakout, as well complete mismanagement of foreign relations amid rising geopolitical risk tensions.
I wouldn’t call it a typical sovereign debt crisis but Australia’s risk profile has deteriorated so why wouldn’t foreign buyers want higher yields to take a punt on us?