Markets had hoped for tighter fiscal policy
Markets had hoped for tighter fiscal policy and a larger reduction in the supply of government debt in last night's Commonwealth budget.
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Interest rate markets were disappointed with the Commonwealth budget relative to expectations, as the market had hoped for tighter fiscal policy and a larger reduction in the supply of government debt.
This disappointment was reflected in:
- The market pricing in the risk of more rate hikes from the RBA – bill futures sold off by 2-5 basis points and yields on cash futures strip rose by 1-4 basis points;
- Receiving in swap spreads on the back of a higher-than-expected supply of bonds – 3-year and 10-year EFPs tightened by about 1bp;
- A wider spread between Australian and US government bond yields – the 10-year spread increased by 3bp prior to the release of the US CPI last night; and
- A steeper yield curve – the 3s10s future curve steepened 2 basis points.
The catalyst appeared to be the deterioration in the headline budget deficit, which includes off-balance sheet spending by the government and drives the issuance of government debt.
The government now expects a smaller starting point for the headline deficit in 2025-26 of 1.6% of GDP (previously forecast at 2.0%), but the forecast deficit in 2026-27 is unchanged at 2.1% of GDP and the shortfall remains large until the final year of the forecast horizon, almost identical to Canberra's December estimates.
The better starting point saw the forecast level of public debt revised lower in every year, but expected gross issuance of all government securities in 2026-27 was still large at $148bn (previously $155bn) given there was no change to expected headline deficit that year. This was higher than market estimates of gross issuance of about $135bn in 2026-27.
The market had hoped that the changes to the National Disability Insurance Scheme (NDIS) and the taxation of housing, capital gains and trusts would see a material improvement in the headline deficit in 2026-27, thereby reducing the supply of government debt.
Instead, the policy changes have little net impact on the budget in the near term because:
- The payoff from the policies is backloaded – the changes to the NDIS save the most money, but only take off from 2027-28 onwards, while the tax changes have their biggest impact on the budget bottom-line in 2029-30;
- The forecast revenue raised by the tax changes is not that big, at least for the first three financial years of their operation; and
- The large NDIS savings are used to spend more on hospitals, defence, a small income tax cut, and pharmaceuticals.
This is shown in the tables below, which reconcile the revisions to the forecast budget deficit from December to now, and provide the estimated cost of the major policy changes and new spending/tax changes.
The most pressing risk to the budget remains the highly uncertain fallout from the unprecedented shock to the world supply of energy and key industrial commodities.
Other more practical risks are that the planned policy changes are watered down in response to political pressure and that the policy costings turn out wrong.
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Based in Sydney, Kieran Davies is Chief Macro Strategist at Coolabah Capital Investments, an asset manager with 65 executives and over $20 billion in fixed-income strategies. Kieran is responsible for macroeconomic research and investment strategy, contributing to the investment decisions of the firm. Kieran has long experience as a macroeconomist in both the private and public sectors. He has worked most recently as Chief Markets Economist for National Australia Bank and was previously Chief Economist, Australia and New Zealand, for Barclays Bank and ABN Amro Bank/RBS. Kieran also worked as Principal Adviser on the macroeconomy and budget policy in the Commonwealth Treasury and Director of Forecasting.
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Based in Sydney, Kieran Davies is Chief Macro Strategist at Coolabah Capital Investments, an asset manager with 65 executives and over $20 billion in fixed-income strategies. Kieran is responsible for macroeconomic research and investment...
Based in Sydney, Kieran Davies is Chief Macro Strategist at Coolabah Capital Investments, an asset manager with 65 executives and over $20 billion in fixed-income strategies. Kieran is responsible for macroeconomic research and investment...
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