Will the Reserve Bank of Australia buck the trend and raise interest rates? Australia's 10-year government bond yield approaches 5%

# Source: Wall Street CN

By Long Yue

Sticky inflation and an unexpectedly strong jobs market have forced the market to reassess the policy path of the Reserve Bank of Australia (RBA). Overnight swap data shows the probability of the RBA raising interest rates by 25 basis points this week has surged to 73%, and the country's 10-year government bond yield has neared 5% for the first time in more than two years. If this comes true, the RBA will become one of the major central banks to tighten policy against the trend amid rising global expectations for interest rate cuts, and the risk of policy divergence is being priced in the bond market first.

As the Federal Reserve and most global central banks shift to a rate-cutting path, Australia may be brewing a radical policy U-turn.

According to the latest Bloomberg report, driven by persistently high inflation and a robust labor market, economists generally expect the RBA to raise the cash rate by 25 basis points to 3.85% this Tuesday. Overnight index swaps indicate the market has priced in a roughly 73% chance of a 25-basis-point rate hike by the Australian central bank.

Yet less than six months ago, the bank attempted to boost the economy with an interest rate cut. This shift also means Australia is likely to become one of the few major economies to opt for policy tightening at the current stage.

## 10-Year Bond Yield Nears the 5% Threshold

The reassessment of the policy path has quickly transmitted to the bond market. Australia's 10-year government bond yield closed at 4.81% last week, spiking to 4.90% after the release of stronger-than-expected inflation data, and many institutions believe it will briefly break through 5% in the coming months.

National Australia Bank (NAB) predicts that if the RBA raises interest rates in February and May, coupled with upward pressure on global sovereign bond yields, the 10-year yield will face further room for an increase.

However, some institutions believe it will be difficult to hold above 5% for the long term. Chris Manuell, portfolio manager at Jamieson Coote Bonds, said: "At these levels, demand will emerge from offshore investors and asset allocators."

## Inflation and Employment Data Reshape Policy Pricing

The turning point in policy expectations stems from a series of recently "unexpectedly strong" data releases.

In the fourth quarter of last year, the core inflation indicator closely watched by the RBA remained at a high level, significantly above the 2%-3% target range. Meanwhile, the unemployment rate, which was expected to edge up gradually, unexpectedly fell to 4.1%, 0.3 percentage points lower than the central bank's forecast.

Stephen Miller, investment strategist at GSFM, bluntly stated: "Inflation is a real and pressing threat, and raising interest rates now is the most appropriate response. Inaction may force the use of more aggressive policy tools in the future."

Nick Stenner, strategist at Bank of America, also pointed out that against the backdrop of inflation remaining persistently above target with upside risks, "keeping interest rates unchanged would raise market doubts about the central bank's commitment to curbing inflation."

## Global Monetary Policy Divergence Intensifies

The potential rate hike by the RBA comes against a backdrop of marked divergence in global monetary policies.

The Federal Reserve and some Asian economies are seen as being close to a rate-cutting window, the euro zone is expected to remain on the sidelines, while Japan still leans toward further tightening.

This divergence has been reflected in exchange rates. The Australian dollar has risen by about 5% year-to-date, ranking among the top major currencies, a move the market views as a "passive tightening" of financial conditions.

National Australia Bank noted that a rate hike this week, if it materializes, is more likely to be an "insurance hike" rather than the start of a new tightening cycle.

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