Australia’s key bond rate is on its way to falling under 4% after hitting another all time low yesterday in the wake of the US Federal Reserve’s shock decision to set a rate band of between 0% and 0.25% for the foreseeable future.

The yield on our 10-year bond closed at 4.13%, the lowest so far recorded and means it is now 0.12% under the cash rate set on December 2 by the Reserve Bank. In addition, the 10-year bond yield is now lower than rates for short-term near cash securities: 30, 90 and 180 day bills.

That’s contrary to the current situation in the US where cash and short-term government bond yields are down from 1% down to almost zero: and that was one of the reasons why the Fed set its historic range for the Federal Funds rate.

The signs are that there is no money being lent in the US of any volume — banks and other lenders are keeping their funds in cash, fearful of going back into the loan market and worried about the possibility of default among their peers and customers.

Macquarie Bank interest rate strategist Rory Robertson says the yield on the 10 year bond is heading under 4% and had dropped 1.50% since mid October. He believes the RBA will cut in February by 0.50% to 3.75% “But the possibilities range from nothing done to another 1% cut,” says Robertson.

Certainly the Australian dollar is helping: it hit a 2-month high in Asian trading this morning at 70.34 US cents as the US dollar continued to lose ground against the euro and the yen. It has now lost more than 8% in three trading days against the greenback and hit a new 13-year low against the stronger yen overnight.

Oil prices sank after OPEC cut its production target by a record 2.2 million barrels a day, to go with earlier cuts of 2 million barrels.

New York oil prices fell to a four-and-a-half year low of $US39.88 before regaining the $US40 a barrel mark. Prices fell more than 7% on the day — so much for the power of OPEC’s cartel strength. It appealed to non-OPEC producers such as Russia and Azerbaijan to join the cutting.

Since when have we heard of a cartel asking non members for help? Dick Pratt’s Visy group and Amcor didn’t make a public call for assistance when they were running the now infamous cardboard box cartel, did they? 

Copper prices traded at $US137.50, the same level as two weeks ago — the metal has lost that 10% gain as concerns grow that the US slowdown is deeper and nastier than first thought, with China also hurting as the housing slump drags the economy towards stall mode.

Our 10 year bond rate is following cash and US rates lower, but because there’s a huge 4% interest rate differential (and ever 3.5% after February), the Aussie dollar should hold up. If conditions settle in January after the end-of-year squeeze, don’t be surprised if Japanese yen investors appear bearing money.

That could happen earlier than if the Bank of Japan cuts its key rate from 0.30% to around 0.10% as suggested in the market ahead of the meeting today.

We have to remember that the current cash rate here of 4.25% is low because the RBA has cut deeply to provide a buffer for the economy ahead of an expected worsening next year; but it’s also a sign that our level of economic activity will still be stronger and more soundly-based than Japan, the US and Europe. It’s as much a recognition of the small inflationary risks that still accompany the Australian economy as anything else.

Those inflationary pressures will stand us in good stead next year as deflation stalks the economies of the US, UK, Europe and Japan. That’s the bottom line of the Fed’s rate cut and quantatative easing: it wants to see some inflationary fires kindled by forcing banks to lend and consumers to consume. No lending and no spending makes for a really depressed economy!