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The bond market is crashing - and it'll affect you
There are two very important trends unfolding in financial markets.
One is the surge in government bond yields, the other is the free-fall of the Australian dollar.
To the bond market first.
In the US, bond yields – or interest rates – have jumped sharply since Donald Trump was elected President and he took the decision to lock in trillions of dollars of government borrowings to fund a range of tax cuts. When Trump was elected, the 10 year bond yield in the US was around 1.9 per cent, with the 2 year yield around 1.0 per cent. Now, with the US budget being trashed and inflation pressures building, those yields have jumped to around 3.2 and 2.9 per cent, respectively.
Part of this surge in yields is linked to the US Federal Reserve hiking interest rates in reaction to the extreme sugar hit to the economy from the extraordinary fiscal policy easing. It is also engaging in quantitative tightening, which is unwinding the money printing that was instigated in the wake of the banking crisis.
The other part of the jump in US yields is linked to expectations of an inflation surge as the economy is flooded with borrowed government money.
In May 2014, then Treasurer Joe Hockey announced that the budget deficit for 2017-18 would narrow to just $2.8 billion. The projections in that budget indicated a return to surplus in 2018-19.
Fast forward a little over four years and Treasurer Josh Frydenberg and Finance Minster Mathias Cormann confirmed that the budget deficit for 2017-18 came in at $10.1 billion, nearly four times the estimate presented in the first Coalition government budget. Progress on repairing the budget has clearly been slow and marginal under the Abbott-Turnbull-Morrison governments, despite some of the strongest global economic conditions in a decade. Policy actions of the Coalition over the five years it has been in office have actually damaged the budget balance with a raft of extra spending, and the quest for a return to surplus has been driven by a strong global economy, not local policy changes.
While the budget deficit was the smallest in a decade, the narrower deficit was based on unexpected riches flowing from surprisingly buoyant prices for iron ore and coal which have seen tax collection rise to levels also not seen in a decade.
This is not to sniff at the good fortune of the current government. It is always great news when the prices of our main commodity exports are strong. It adds to Australia’s national income, adds to government tax revenue and should always been welcome.
But it is important to realise it is simple luck rather than good economic management.