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The report in the Australian Financial Review today confirms that the Abbott government's fiscal strategy is in tatters.
Elected on a platform to 'fix the budget' and tackle the 'budget crisis and emergency', the Abbott government is now planning a mini-budget in December to deal with the fact that its policies have resulted in a budget deficit blow out that at this stage, looks to be about as significant as some of the misses of the previous government.
According to the AFR, the Abbott government has capitulated on measures that would have lowered the budget deficit by around $30 billion over four years, which only adds to the frenzied spending by the Abbott government on RBA payments, national security, roads, defence and paid parental leave, among other things. Add to that a negative shock from the fall in commodity prices and the terms of trade, and the budget deficit projections that will be in Mid Year Economic and Fiscal Outlook will dwarf the numbers the Abbott government inherited in Pre-Election Fiscal Outlook.
OK – the US economic recovery still seems robust enough to see the US Federal Reserve moving to hike interest rates over the next couple of years. It is not fanciful to suggest that the Fed funds rate will be near 1.5 to 2 per cent some time in 2016. Hardly draconian, but it would be part of the long run process of normalising monetary policy after the Lesser Depression of 2008 to 2011.
In Australia, the free-fall in the terms of trade, fiscal tightening, persistently glum consumer sentiment and the near certainty that house prices will stop rising – they could even fall modestly – suggests that the RBA will be moving to cut interest rates in the not too distant future. Indeed, it is not fanciful to think that the cash rate in Australia will be near 1.5 to 2 per cent some time in 2016.
The divergent economic trends and monetary policy settings will also play into the bond market. US bond yields will rise as the Fed hikes interest rates and the 10 year bond, currently yielding around 2.5 per cent, would likely trade near 3.5 per cent on the back of solid and sustained growth and Fed interest rate hikes.
For Australia, in a disinflationary funk, it would be likely that 10 year yields would fall from current levels around 3.5 per cent.