Bond markets tell the tale of 'old economy' Australia
It's fair to say that news that the rates of US and Aussie two-year bonds are now equal was not met by the popping of champagne or dancing in the streets.
American and Aussie two-year government securities now both yield around 1.75 per cent. It's the first time in 20 years that the two rates have touched, and analysts expect the forces that have pulled them together will continue and push Aussie yields below their American counterparts.
This is not a milestone to be celebrated because the story of the converging rates is one of relative economic underperformance. Our economy appears stuck at below trend rates of growth, while the US - and Europe - is gathering momentum.
The next question is whether longer term rates will also converge and potentially "invert". Opinions are divided, but it's hard to escape the feeling that this would represent an even gloomier outlook for Australia's longer term economic performance.
The margin between the two 10-year rates is a very skinny 20 basis points: a yield of 2.5 per cent from local 10-year bonds, against 2.3 per cent in the US.
"There's a very good chance over the next year or so" that 10-year Aussie yields will drop below their US cousins, Ardea Investment Management's Tamar Hamlyn says.
"The reason is simple: 10-year bond yields ultimately reflect growth rates," Hamlyn says. Australia is doing "OK", he explains, but it's not expected to increase its growth rate "any time soon, whereas the US has had a longer period of monetary stimulus and there is every expectation that the US economy will continue to improve".
The trend at the shorter end of the bond market "is entrenched and is likely to continue", BT Investment Management's Vimal Gor says. But this doesn't mean that the spread difference at the 10-year point should continue to compress.
"At the long-end of the curve the supply and demand dynamics are of the greatest importance, and we think that the 10-year spread heads wider again in the new-year," he says.
Markets as recently as September were pricing in as many as two RBA rate hikes next year,but have since rapidly recalculated those odds in the wake of weak inflation numbers and another disappointing wage growth outcome.
Now fixed income traders have pushed out a rate hike until early 2019. RBA minutes and a speech from the governor last week added to the idea of a central bank in no rush to move, despite the broader trend towards tighter monetary policy.
With no obvious sparks for the local economy, the currency could be key, Altius Asset Management's Bill Bovingdon says.
"If the currency responds – approaches, say, US70¢ - then local growth and inflation will be upgraded and cash rate rises become a higher probability in the second half of 2018," he says.
If the Fed follows through with three or four rate hikes next year, then Gor expects the US dollar to "be much stronger and the Aussie to be much weaker".
A much weaker currency would import consumer price inflation and provide a boost to our exports, both factors conducive to higher RBA rates.
It's not a dire economic picture, just a relative one. After all, it's hard to be too pessimistic when most everybody has jobs and the labour market is in such robust shape, despite the lack of wages growth.
Indeed, employment has grown for 12 consecutive months, the longest uninterrupted streak since 1994, points out ANZ's Martin Whetton. It's those kind of positive aspects that RBA governor Philip Lowe is quick to highlight.
In any case, central bankers, economists and the average person on the street who reads the business pages knows the economy's Achilles Heel.
Household debt stands at close to 200 per cent of disposable income, making Australians among the most indebted in the world. The last time we had a recession in the early 1990s, the ratio stood at more like 75 per cent.
That lack of a recession over the intervening years explains in part why we have higher levels of debt relative to peers in other advanced economies.
"More fundamentally," Citi economist Joshua Williams says, "the build-up of debt over the past two decades reflects higher and higher mortgage shares in household balance sheets". In other words, we have just been prepared and willing to dedicate more of our income to paying a mortgage.
Households have to deal with the increased debt servicing costs at a time of below trend disposable income growth. To date, households have been using savings to support some expenditure but there is a limit to that.
It's perhaps no coincidence that the last time the two-year Aussie yield was consistently below its American counterpart was in the late 1990s leading into the US tech bubble and bust.
American technology firms are once again leading Wall Street to fresh heights, and this time in significantly less frothy fashion.
A similar, albeit maybe less sustainable, phenomenon is happening in China with the rise of the likes of Tencent and Alibaba. Where are the Australian tech champions?
The even less cheery signal of converging yields is of an economy that is being left behind.
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