Interest Rates to mean revert

In January 2022, the Australian 2 year government bond was yielding 0.40%.

The Reserve Bank of Australia’s (RBA) cash rate was 0.10%.
7 months later, the yield in the Aussie 2’s rose 9-fold, up to a recent high of 3.50%.

Today, they are 2.97%.

‘Shorting’ bonds and long commodities was your inflation trade. That’s all over now.

Now, the RBA’s cash rate is 1.35% which is a 13-fold increase from that January 2022 rate.

The designed and manufactured mid cycle slowdown is working for them.

I don’t think the RBA increases rates to anything close to 2%.
Commodity prices have been falling and I’m expecting an inventory ‘discounting’ war which will aide the abating or moderation of inflation.

The prices of assets in various markets are telling me that inflation has peaked.

This means, I think interest rates also decline.

I’ll look for the Australian 2 year government bond yield to move lower towards the 1.50% – 1.60% range over time. It won’t occur in straight line, however probability of a mean reversion increases notably following parabolic price rises.

Arguably, you don’t want to fix your borrowing costs.

A move lower in interest rates is inherently positive for equity prices (more so for technology stocks) along with bond prices.

Although it bodes poorly for oil prices, many commodities and generally, the Australian Dollar.

By the way, Lower oil prices are good for overall corporate earnings as are cheaper commodity ‘inputs’.

And keep in mind that Copper has already declined 35% and usually leads the direction of credit market yields.

July 22, 2022

by Rob Zdravevski

rob@karriasset.com.au

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