Aussie Spurring Biggest Bond Rally Since 2008: Australia Credit

Australian government bonds are poised for their biggest quarterly rally in more than two years as investors seeking alternatives to the U.S. dollar and euro buy the so-called Aussie.

The nation’s debt has delivered a 5.33 percent return this quarter, the most since posting a 9.18 percent gain in the last three months of 2008, Bank of America Corp. indexes show. The Australian dollar has risen 5.5 percent from its 2011 closing low on March 17, according to Bloomberg Correlation-Weighted Currency Indexes, which track 10 developed-market peers.

Global investors are seeking out nations that offer protection from the debt and deficit turmoil roiling developed markets such as Europe, the U.S. and Japan. The Aussie has surged 48 percent versus the U.S. dollar since the end of 2008, beating all of more than 150 peers tracked by Bloomberg, as investors sought to benefit from Australia’s links with China, the fastest-growing major economy.

“Though Australian bond yields are quite low historically they’re still very high on an international comparable basis and that is what’s important for the currency,” said Richard Grace, the Sydney-based chief foreign-exchange strategist and head of international economics at Commonwealth Bank of Australia. “Sovereign downgrades in the U.S. and Europe and the very low interest-rate environment that’s likely to persist in both economies for some time means reserve managers are looking elsewhere for yield.”

Renewed fears that European policy makers are failing to prevent a Greek default and contain their debt woes last week prompted investors to sell stocks and push the euro to a more-than-six-month low against the dollar.

Relative Yields

Australia’s benchmark 10-year government bond yield fell 12 basis points, or 0.12 percentage point, to 4.15 percent, set for its lowest close since March 2009. While that is down from this year’s high of 5.84 percent in February, the rate compares with 1.92 percent on similar-maturity notes in the U.S., 1.77 percent in Germany and 0.99 percent in Japan.

The U.S. dollar’s share of global currency reserves dropped in the first quarter to the lowest level in at least 12 years, the most recent International Monetary Fund data show. The euro’s share fell to 26.6 percent from 27.6 percent at the end of 2009. Holdings in the other currencies category -- which UBS AG said in July is “most likely” to be the Aussie and Canadian dollar -- climbed to 4.7 percent from 3.1 percent.

“There’s been an ongoing flow into Australian assets,” said Dale Thomas, head of currency management at Insight Investment Management Ltd. in London, who helps oversee more than $121 billion. “We’re not very big fans of either the U.S. dollar or the euro, and I think that’s a fairly standard position, so in that environment people will want to continue to hold the Australian dollar.”

‘Global Meltdown’

This year’s rally in Australian debt is also being driven by investors hedging against a “global meltdown,” seeing the Reserve Bank of Australia as one of the few developed-nation central banks with the scope to substantially cut interest rates, Thomas said. Australian bonds returned 10.2 percent this year, the most of 26 markets tracked by Bloomberg/EFFAS Bond Indexes after Hungary’s 10.3 percent gain.

Yields on bonds due in 10 years have dropped from an eight-year high of 6.81 percent on June 17, 2008, as the RBA lowered rates from 7.25 percent to 3 percent by May 2009. An investor who had bought the March 2019 benchmark notes on June 17 and sold the securities seven months later would have earned a 28 percent return, according to data compiled by Bloomberg.

Global stocks dropped last month by the most since May 2010 after Standard & Poor’s cut the U.S.’s credit rating from AAA on Aug. 5 and Europe struggled to bail out indebted nations.

‘Dramatic Change’

“If we did see a very dramatic change for the worse in the global economy, certainly we have plenty of interest rates to play with if need be,” RBA Governor Glenn Stevens told lawmakers on Aug. 26. “There would be not that many countries who could say they had more than us in the event of a really big episode.”

Stevens raised borrowing costs seven times beginning October 2009 to 4.75 percent reach 4.75 percent in November 2010 to help control inflation amid the nation’s biggest-ever mining investment boom.

That spurred gains in the Australian dollar to as much as $1.1081 on July 27, the strongest since it was freely floated in 1983, before trading at $1.04 as of 10:20 a.m. in Sydney.

One of the things that is “good about the Australian dollar is that the central bank endorses free markets and welcomes a free floating currency as a way to mitigate domestic inflationary pressures,” said Axel Merk, president and chief investment officer at Merk Investments LLC in Palo Alto, California.

Franc Ceiling

The Swiss central bank on Sept. 6 imposed a ceiling on the franc for the first time in more than three decades. The move followed the Bank of Japan’s Aug. 4 intervention, when it sold 4.5 trillion yen ($58 billion) to weaken the currency.

Futures traders increased bets the Australian dollar will gain against the U.S. currency, while they cut wagers on advances in the yen and franc, figures from the Washington-based Commodity Futures Trading Commission show.

The difference in the number of wagers by hedge funds and other large speculators on an advance in Aussie compared with those on a drop -- so-called net longs -- was 48,041 on Sept. 6, compared with net longs of 47,569 a week earlier.

Yields Below Cash

Benchmark 10-year bond yields in Australia slid for an eighth month in August, the longest stretch of declines since 1991. The yield fell 14 basis points last week. Yields on all Australian bonds, including the longest-dated security maturing April 2023, have been lower than the cash rate since Aug. 9.

Cash-rate futures show traders are betting Stevens will cut the benchmark to 3.98 percent by December from 4.75 percent currently.

Fed policy makers pledged Aug. 9 to keep the U.S. benchmark at a record low of zero to 0.25 percent at least through mid-2013 to bolster the economy. Chairman Ben S. Bernanke said Sept. 8 the central bank will discuss the tools they could use to boost the recovery at this month’s meeting.

“Small and large investors alike are seeking to spread the risk of something as mundane as cash by diversifying to other currencies, including the Australian dollar,” Merk said. “As Fed action on the U.S. appears more likely now, we started increasing our Australian dollar holding again in recent days,” after reducing investments when the currency neared $1.10, he said in an e-mailed response to questions.

Selling Euros

Merk said separately in an e-mailed note Sept. 9 that his hard currency fund with $700 million in assets has re-allocated some euro assets into Aussie as the European Central Bank may cut interest rates as early as next month.

The Australian currency dipped below parity with the U.S. dollar on three occasions since the end of February; just before Japan’s March 11 earthquake; after that temblor; and on Aug. 9 as the U.S. downgrade triggered concern France’s rating may also be cut. The Aussie averaged 73.78 U.S. cents in the 10 years to Dec. 31.

Three-month implied volatility for the Aussie-U.S. dollar exchange rate peaked this year at 18.6 on Aug. 9, lower than 2010’s peak of 23.1 which came a day before German lawmakers approved their country’s share of a 750 billion euro ($1.04 trillion) bailout package for the region on May 21. In 2009, the gauge of price swings in the currency reached a high of 27.6 amid the global financial crisis.

‘Larger Players’

“In the three major financial market episodes we’ve had since 2009, the volatility we’ve seen in the Aussie has been proportionately less,” said CBA’s Grace. “You’ve got more and larger players coming in and buying the Aussie on dips.”

The currency will end this year at $1.06, according to the median forecast of 34 analysts in a Bloomberg News survey, up from predictions at the start of the year for 97 U.S. cents.

Concern the global economic recovery is stalling boosted the perceived risk of Australian corporate bonds.

The Markit iTraxx Australia index of credit-default swaps rose 20 basis points to 192.5 basis points as of 8:53 a.m. in Sydney, according to Australia & New Zealand Banking Group Ltd. The bond risk benchmark is on course for the biggest daily increase since May 7, 2010, and the highest close since July 2009, according to CMA.

The extra yield investors demand to own company bonds in Australia instead of similar-maturity government debt rose to 224 basis points last week, the most since 2009, from 222 at the end of last month, according to Bank of America Merrill Lynch’s Australian Corporate & Collateralized Index.

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