Down, down, the cash rate is coming down!

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By David Law­son

Click here for excel data: Debt­watch; CfE­SI

The recent stall in Com­mon­wealth Gov­ern­ment Secu­ri­ties on issue will con­tin­ue to put pres­sure on the Reserve Bank of Aus­tralia to reduce the cash rate. As not­ed by Glenn Stevens in this weeks Media Release on the June Mon­e­tary Pol­i­cy Deci­sion:

‘Long-term inter­est rates faced by high­ly rat­ed sov­er­eigns, includ­ing Aus­tralia, have fall­en to excep­tion­al­ly low lev­els.’

10-year bond yields aver­aged a decline of 3 basis points per trad­ing day for the month of April. The spread on gov­ern­ment bond yields and the Tar­get rate con­tin­ues to widen.

It is crys­tal clear that the force behind the demand from investors is the desire for a safe haven when risky assets are so down­side volatile, but what about the CGSs sup­ply side of the mar­ket? The CGSs mar­ket was increas­ing at an aver­age rate of 3% per month since Sep­tem­ber 2008, but this growth engine has since stalled. In April Com­mon­wealth Secu­ri­ties on issue declined by 4%, in a peri­od of height­ened uncer­tain­ty and volatil­i­ty in the glob­al finan­cial mar­kets. This could be seen as the result of a leg­is­la­ture-imposed sup­ply con­straint, giv­en the Aus­tralian Fed­er­al gov­ern­men­t’s debt ceil­ing, as shown in State­ment 7 of the 2012 bud­get:

 CGS on issue sub­ject to the cur­rent leg­isla­tive lim­it is pro­ject­ed to be below $250 bil­lion at the end of each finan­cial year across the for­ward esti­mates…

At a 3% month­ly growth rate, CGSs on issue would have sur­passed the $250 bil­lion ceil­ing last month.

With the Aus­tralian Fed­er­al Gov­ern­ment approach­ing their cred­it lim­it, CGSs are inher­ent­ly feel­ing the pres­sure of scarci­ty, dri­ving up prices and push­ing yields down. This is giv­ing weight to some­what sub­jec­tive state­ments about fur­ther inter­est rate cuts this year in the press, where­by the RBA will need to con­tin­ue cut­ting the cash rate to fol­low the trend of gov­ern­ment bond yields.

This ceil­ing is encum­brance on for­eign buy­ers on have brought up large amounts of the CGSs, adding to our offi­cial-net for­eign debt lev­els.

Which has also played a pri­ma­ry role in over­in­flat­ing of the Aus­tralian dol­lar.

Nat­u­ral­ly, as inter­est rates fall fol­low­ing bond yields, the Aus­tralian dol­lar will come back to a more real­is­tic val­u­a­tion, and we will soon dis­cov­er that Aus­tralia is in fact not dif­fer­ent!