Traders See 41% Chance of Lehman-Style Cut: Australia Credit

Reserve Bank of Australia Governor Glenn Stevens
Governor of the Reserve Bank of Australia Glenn Stevens. Stevens stated last month that rates may rise to contain Australia's biggest mining boom in a century. Photographer: Patrick Hamilton/Bloomberg

Traders are adding to bets Australia’s central bank will repeat its emergency interest-rate cuts of 2008 as the economy falters and concern intensifies that U.S. and European debt burdens will derail global growth.

The yield on December cash-rate futures was 4.345 percent as of 4:45 p.m. in Sydney. That implies the Reserve Bank of Australia will lower its benchmark of 4.75 percent to 4.5 percent by year-end, and a 41 percent chance of a reduction to 3.75 percent. Ten-year government bond yields fell the most this week since since December 2008.

The rally in bonds comes after statements from RBA Governor Glenn Stevens last month that rates may rise to contain Australia’s biggest mining boom in a century. Economists have pushed back forecasts for when rates will increase amid a proposed carbon tax and the lowest business confidence in six months. Westpac Banking Corp. today became the first among Australia’s four biggest lenders to predict a cut in the benchmark in December.

“People are fundamentally reassessing the economic outlook for Australia,” said Sally Auld, a Sydney-based interest-rate strategist at JPMorgan Chase & Co. “The question then becomes what might drive the RBA to cut: Either something goes catastrophically wrong in Europe, in which case they’ll cut by 100 basis points, or the domestic economy continues to weaken.”

Stevens slashed the cash rate to 3 percent from 7.25 percent between September 2008 and April 2009, in a record stretch, to counter a global credit freeze. The RBA’s post-Lehman reaction included three rate cuts of 100 basis points each, the first time the central bank had moved by more than 25 basis points at a time since 2001.

Yields Fall

Australia’s 10-year yield fell as low as 4.90 percent today, the least since Sept. 8, from this year’s high of 5.84 percent on Feb. 8. It dropped 32 basis points, or 0.32 percentage point, this week to 4.91 percent as of 4:59 p.m. in Sydney, or 2 percentage points more than similar-maturity Treasuries.

Two-year Australian yields fell to 4.33 percent, down 41 basis points since June 30, and are set for a third monthly drop.

“The move to lower yields at the front of the curve has been the real pain trade and a lot of people have lost a lot of money,” said Auld. “That means the appetite to put on any risk is very minimal, especially in a world where you really don’t know what’s going to happen one day to the next in Europe.”

Consumer Confidence

Australian consumer confidence fell this month by the most since 2008 as concern intensified that Europe’s debt crisis is getting worse, according to a Westpac Banking Corp. and Melbourne Institute survey released July 13.

The RBA will raise the official cash rate a quarter of a percentage point to 5 percent in November, according to the median estimate of 21 economists surveyed by Bloomberg News this week. A survey three weeks ago showed the median prediction was for a rate increase in August.

Governor Stevens will begin a “sequence of rate cuts” and start by lowering the key rate to 4.5 percent in December, Bill Evans, Westpac’s chief economists, wrote in an emailed note today. The RBA will reduce its benchmark by 100 basis points in total through 2012 before holding it unchanged in 2013, he said.

Greece has about a one in 10 chance of sidestepping default, according to credit traders who are betting the country will be crippled by $490 billion of debt -- more than $40,000 for every citizen. Italy has about 1.8 trillion euros ($2.54 trillion) of debt, more than Greece, Spain, Portugal and Ireland combined.

Debt Limit

U.S. Treasury Secretary Timothy F. Geithner warned lawmakers there’s no possible extension to the time limit to raise the federal debt ceiling as Standard & Poor’s became the second ratings company this week to say it may downgrade the U.S.’s top credit rating.

Investors are accepting the lowest yields on Australian government securities maturing in less than a year since the period following Lehman’s collapse. Every tender since June 9 has drawn a weighted average yield less than the benchmark rate.

Notes maturing on Oct. 21 were priced to yield 4.6493 percent at yesterday’s tender, the biggest discount to the cash rate since May 2009.

Retailer David Jones Ltd. announced July 13 that it expected profit to drop as much as 12 percent in the half-year ending this month, just two months after Australia’s second-largest department store chain forecast a 5 percent increase.

Business confidence fell to a six-month low in June due to a strengthening currency and signs of weaker global growth, a study released July 12 showed.

Consumer Prices

Australian government bond and inflation-indexed note yields show investors expect consumer prices will rise an annual 2.8 percent for the next 10 years.

The RBA started lifting borrowing costs in October 2009 as credit markets thawed, the first Group of 20 nation to raise rates after the global financial crisis. Investors piled in to the Australian dollar, the world’s fifth-most traded currency, to take advantage of the higher yields, pushing it up 20 percent against the greenback in the past 12 months.

Australia’s strengthening dollar is a burden for many of the nation’s industries, Treasurer Wayne Swan said yesterday.

The so-called Aussie traded at $1.06511 today and will buy $1.04 at the end of 2011, according to the median forecast of 37 strategists surveyed by Bloomberg. The currency climbed to $1.1012 on May 2, the highest since exchange-rate controls were scrapped in 1983.

Bond Returns

The nation’s sovereign debt has gained 6 percent this year, including reinvested interest, the best return after New Zealand among 20 developed markets tracked by Bank of America Merrill Lynch indexes. That compares with 3.4 percent for the U.S. and 2 percent for Germany.

Portuguese bonds are the worst performers, generating a 27.6 percent loss, followed by Irish debt’s 21.6 percent drop and a 2.5 percent decline for Italy’s securities.

Traders of cash-rate futures began pricing in the chance of an Australian interest-rate cut by year-end on June 16. The European Central Bank warned the day before that the threat of the Greek debt crisis spilling over into the banking sector was the biggest risk to the region’s financial stability.

“We think the RBA is near the end of its tightening cycle,” said Brad Gibson, head of rates strategies at ING Investment Management in Sydney, overseeing about A$14 billion in fixed-income funds. “Given the deteriorating global situation it is increasingly difficult to see an RBA hike in the months ahead, though a higher cash rate in Australia in the medium term is still our central case.”

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