Aussie Borrowing Held Hostage to Fed Impact From Ore to Yields

  • Iron ore slide estimated to cut A$7 billion from tax receipts
  • AOFM to sell A$12.5 billion more bonds, linkers through June

Australian Treasurer Scott Morrison needs markets to take Wednesday’s Federal Reserve meeting in their stride, after global turmoil blew holes in the nation’s budget plans.

Morrison said Tuesday in Perth that the underlying cash deficit in the year through June would be 6.6 percent wider than forecast in May after commodity prices slumped and wage growth sagged to levels normally seen during recessions. Australia will sell A$12.5 billion ($9 billion) more bonds and inflation-linked securities than previously projected, the government’s financing arm said Wednesday. The new estimates hinge partly on iron ore remaining close to its current price, after dropping almost 50 percent this year. The big risk: the Fed.

“The key thing that we are looking at to access those outcomes is the path of the U.S. dollar and whether the likely Fed tightening this week materially changes currency markets and, therefore, commodities respond to that as they often do,” said Adam Donaldson, head of debt research at Commonwealth Bank of Australia. “This is all pretty small beer compared to those global forces.”

Australia, the world’s fourth-largest AAA sovereign market, saw demand ebb for its bonds this year even as sales climbed. Foreign investors, the biggest buyers, have reduced their stake in the nation’s debt to the lowest in six years and average demand at government auctions fell to the weakest since 2002.

Morrison reduced the government’s assumption for iron ore prices to $39 per metric ton on Tuesday from $48 in May, saying the slide in prices was projected to detract about A$7 billion from tax receipts in the four years through June 2019. The steel-making material has dropped 30 percent this quarter touching a low of $38.30 on Dec. 11.

“The question becomes: why is iron ore going to bounce any time soon?” said Sally Auld, head of fixed-income and currency strategy for Australia at JPMorgan Chase & Co. “You would think we’re getting closer to the trough, which limits the damage the whole iron ore story can do. To me there was an opportunity to come out with something a bit horrible,” and then deliver better news at the pre-election budget next May, she said.

Fed Liftoff

There is a 76 percent chance that the Federal Open Market Committee will raise its benchmark from near zero on Dec. 16, futures pricing shows. A gauge of the greenback has climbed nearly 9 percent this year and the biggest banks trading in the foreign-exchange market predict the currency will appreciate again in 2016.

A stronger U.S. dollar may add pressure on iron ore prices that dropped this year as mines including those run in Australia by Rio Tinto Ltd. and BHP Billiton Ltd. ramp up supply even as growth slows in China, the largest consumer. 

There has been a strong inverse relationship between commodities and the dollar ever since the financial crisis, meaning one falls when the other is rising, according to a March report by fund manager Schroders Plc.

Aussie Weakness

Australia’s dollar has been swept up in the greenback’s move, losing 12 percent this year to 71.93 U.S. cents as of 9:11 a.m. Wednesday in Sydney. It will probably trough at 68 cents next year, according to the median estimate of forecasts compiled by Bloomberg.

The nation’s deteriorating debt profile also comes at a time when markets are wary of the Fed liftoff driving bond yields higher around the world. The U.S. 10-year yield is predicted to climb 55 basis points through next year, outpacing a 32 basis point rise for Australia.

The gap between the two was 59 basis points, below the 152 basis points it has averaged over the past decade.

Total government securities outstanding will probably climb to A$429 billion as of June 30, from the A$415 billion forecast in May, according to Tuesday’s update. That would mean a A$60.3 billion increase over debt on issue as of June 30, 2015, the second-largest boost on record.

The market has already seen foreign bond buyers struggling to keep pace with the country’s growing debt pile, with offshore holdings of outstanding sovereign securities sliding to 63.6 percent last quarter, the least since 2009, based on official data.

“Two-thirds of our funding comes from offshore and, in a rising rate environment where the currency is falling, it’s not as attractive for many people,” said Martin Whetton, an interest-rate strategist at Australia & New Zealand Banking Group Ltd. That could make it more difficult for the government, he said.

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