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Berlusconi Boosts Demand for Bonds Down Under: Australia Credit

Berlusconi Boosts Demand for Bonds Down Under
Commercial buildings stand in the central business district as the sun sets in Sydney. Australia’s gross debt will comprise 27 percent of GDP this year, according to estimates by the International Monetary Fund. Photographer: Brendon Thorne/Bloomberg

Australian government bonds are poised to snap four months of losses as Italy’s election deadlock revives demand for the highest-yielding top-rated sovereign debt.

The notes handed investors a total return of 0.8 percent this month through yesterday, according to Bank of America Merrill Lynch index data, ending the longest losing stretch since December 2010. Australia may return its budget to surplus next year, while Italy’s deficit is projected to swell to 3.4 percent, according to the Organization for Economic Cooperation and Development.

Italy’s voters handed former leader Silvio Berlusconi a blocking minority in the Senate, sparking concern that turmoil in Europe will undermine prospects for a global economic recovery. Australian notes had been on course for a five-month losing streak that would have matched a stretch in 1994 as the longest bond rout on record in the Bank of America data. The debt, with benchmark yields that are 172 basis points higher than the average of the nine other AAA markets, also benefited as the Reserve Bank said it still has room to cut rates.

“When there is a bit of a wobble globally, Australia becomes a beneficiary again in a world where there are fewer AAA nations,” said Su-Lin Ong, Sydney-based head of Australian economic and fixed-income strategy at Royal Bank of Canada. “The general upward bias in yields has been unwound a bit recently. What we’ve seen in the last few days is a reminder that there is still uncertainty out there, most obviously in Europe.”

Smaller Debt

Australia’s gross debt will comprise 27 percent of GDP this year, according to estimates by the International Monetary Fund. Italy’s debt burden will be almost five times as much at 128 percent, projections from the Washington-based lender show.

The number of nations holding the highest score from all three major ratings companies shrank this month as Moody’s Investors Service stripped the U.K. of its AAA grade. Among the eight top-rated sovereign markets that also have “stable” outlooks from the biggest credit assessors, Australia is the largest borrower after Canada with A$263 billion ($270 billion) of debt outstanding.

Yield Drops

Australia’s benchmark 10-year yield fell eight basis points this month to 3.36 percent today. It closed at 3.34 percent yesterday, the lowest since Jan. 25. The rate climbed 46 basis points in the four months ended Jan. 31, the longest stretch since December 2010. Italian yields climbed 41 basis points to 4.9 percent on Feb. 26, the biggest daily increase since December 2011.

Yields in Australia rose earlier this month as faster growth and improving manufacturing in China, the South Pacific nation’s biggest trading partner, boosted the outlook for overseas shipments.

Prices for iron ore, Australia’s biggest export, touched $158.90 a dry ton on Feb. 20, the highest since October 2011, according to a gauge compiled by The Steel Index Ltd. UBS AG said this week the key steelmaking ingredient may slump to $70 a ton in the third quarter, which would take it to the lowest level since 2009, as China boosts production and global supply climbs.

RBA Stimulus

RBA Governor Glenn Stevens said Feb. 22 that “there is a good deal of interest-rate stimulus in the pipeline” after he and his board kept the overnight cash-rate target at 3 percent earlier this month. While interest-rate swaps data compiled by Bloomberg show expectations for policy makers to refrain from cutting borrowing costs when they next meet on March 5, traders see about an 80 percent chance of the rate dropping to a record 2.75 percent or lower by the June 4 decision.

The Australian dollar surged 46 percent since the end of 2008, the biggest gain among more than 150 currencies tracked by Bloomberg, and bought $1.0261 as of 12:14 p.m. today in Sydney.

The RBA said the so-called Aussie is held the country’s currency is held by as many as 34 central banks from Reykjavik to Santiago, and models suggested it was as much as 15 percent overvalued, according to papers released today under a Freedom of Information Act request by Bloomberg News.

The Aussie’s strength has been a drag on growth. From a September 2011 peak to the end of 2012, there has been a 17 percent decline in the terms of trade, or the windfall that Australia gets from its exports, the central bank estimated this month.

Investment Falls

The statistics bureau said today business investment declined 1.2 percent in the three months ended December from the previous quarter, contrasting with economist forecasts for a 1 percent gain. Other data released in February showed an unexpected slide in retail sales, a third monthly drop in full-time employment and the biggest decline in 10 months in home-loan approvals.

RBA Assistant Governor Guy Debelle said in a Feb. 26 speech policy makers still “retain scope to lower interest rates further, should the need arise, including to counterbalance the pressures of an elevated exchange rate.”

Even after 1.75 percentage points of reductions in the past 16 months, Australia’s benchmark interest rate remains the highest among major developed economies. It compares with a record-low 0.75 percent in the euro zone and near-zero rates in the U.S. and Japan. Economists surveyed by Bloomberg News expect the South Pacific nation’s economy to grow 2.7 percent this year, compared with a projected 1.1 percent rate for Group of 10 nations and a 2.4 percent pace globally.

Japan Selling

Japanese investors cut their holdings of Australian bonds by 652.6 billion yen ($7.1 billion) over November and December, the most in Ministry of Finance data going back to 2005. Some investors are selling Australian assets as the yen stabilizes after a four-month rout, said Hideo Shimomura, who helps oversee the equivalent of $64.8 billion in Tokyo as chief fund investor at Mitsubishi UFJ Asset Management Co., a unit of Japan’s largest publicly traded bank.

“There is a lot of selling pressure from Japan,” Shimomura said. “People are starting to take profits. There are outflows from our Australia funds every day.”

Japanese investors have been selling Australian assets for about four months, he said. The Aussie was at 94.97 yen today, after reaching a 4 1/2-year high of 97.73 yen on Feb. 25.

Risks ‘Mitigated’

Risks to Australia’s top credit rating “appear to be largely mitigated for now,” Standard & Poor’s Associate Director Craig Michaels said in a statement yesterday. “Australia’s wealthy and open economy withstood the global financial crisis better than most other developed economies, and we expect public debt to peak at a low level before gradually declining.”

Italian elections this month produced a hung parliament, creating the risk of another round of balloting later this year. European Union President Herman Van Rompuy warned that backsliding on budget discipline and economic reforms would shatter market confidence in the 17-nation currency union’s crisis management.

“Australian assets are very attractive with their AAA credit rating and no threat of a downgrade,” said Kei Katayama, who buys non-yen debt for Daiwa SB Investments Ltd. in Tokyo, which manages the equivalent of $54.2 billion and is part of Japan’s second-largest brokerage.

Daiwa SB holds more Australian bonds than the percentages in the benchmarks it uses to gauge performance and will probably buy more, Katayama said.

“There’s a flight to quality, and it’s a quality asset,” he said.

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