Following the surprise rate cut by the People’s Bank of China, uncertainty around China’s growth outlook has increased. This, combined with lower global bond yields, a falling iron ore price and interpretation of recent RBA speeches, has pushed longer term yields lower, flattening the yield curve. In fact, the overnight index swap market is now pricing a better than 50% chance of a rate cut by September 2015 - this was less than 30% only a week ago (refer chart below).
The Australian dollar hit its lowest levels since early July 2010 last week, having just retraced more than 50% of the entire 2008-2011 run up from 60 cents to $1.11. The catalyst for the latest move down was the rate cut in China, as well as lingering reaction to a speech by Deputy RBA Governor Philip Lowe a week ago where he hinted at another rate cut. Lowe said that Australia is in a fortunate situation in that if we do need lower rates we could cut again if necessary – but also added that he doesn’t think we are there yet. While a bit of an ”each way bet”, the market reacted by pushing rates and the Australian dollar lower.