- Benchmark 10-year yields are down half a percentage point
- Bonds will remain supported given risk environment: Morriss
Australian bonds are having their best start to a year since the economy was last in recession in 1991 as concerns about Chinese currency devaluations, banking stability and a U.S. economic slowdown drive investors to the safest assets.
The nation’s benchmark 10-year yield has dropped half a percentage point since Dec. 31 to 2.38 percent as of 5 p.m. on Thursday in Sydney. It sank Tuesday by the most since 2013. Government debt hasn’t had this kind of start to a year since the recession a quarter of a century ago that helped push unemployment to a peak of more than 10 percent and caused a number of local financial institutions to fail.
While robust job creation and buoyant consumer confidence suggest the economy is unlikely to slide into recession, growth remains susceptible to collapsing commodity and equity prices and a significant slowdown in China, Australia’s top trading partner. The nation’s also exposed to global financial sector risks, which have figured prominently for investors in recent days amid questions about Deutsche Bank AG’s ability to pay coupons on its riskiest bonds.
“There’s been a flight to quality with investors switching from equities and flows out of credit markets also supporting sovereign bonds,” said Tony Morriss, an interest-rate strategist at Bank of America Merrill Lynch in Sydney. “There is still much to support bonds at present -- credit pressures, rising concerns about the outlook for U.S. growth and a likely further depreciation of the yuan will all weigh on risk appetite. ”
The Bloomberg AusBond Treasury index has delivered a total return of 2.6 percent since Dec. 31, the most for a comparable period since 1991 and exceeding the gains made through the whole of 2015. The nation’s 10-year yield offered a 0.71 percentage point premium over U.S. debt of similar maturity, after reaching a one-year high of 0.84 on Monday.
The rally has wrongfooted most forecasters. The median prediction in a Bloomberg survey of 19 analysts last month was for bonds to fall and drive the Australian 10-year yield up to 2.9 percent by March 31. The estimate for the two-year rate was 1.98 percent, compared with 1.76 percent on Thursday.
While the bonds look expensive, the disquiet spreading through global markets limits the scope for yields to rise, Morriss said.
This year’s financial market turmoil has wiped about $7.7 trillion from global equities while the Bloomberg Commodity Index was down 5.9 percent in 2016 as of Wednesday. Investors were rattled in January when policy makers in China lowered the yuan’s daily reference rate for an eight-day stretch, raising concern the Asian nation was resorting to currency depreciation to revive the slowest economic growth in a quarter century.
In the U.S. a rout in junk bonds, stagnant consumer spending and a contraction in manufacturing have called into question the economy’s growth path and spurred traders to pare bets on when the Federal Reserve will next lift interest rates. U.S. 10-year Treasury yields sank to a one-year low of 1.67 percent on Wednesday.
Australian markets haven’t been spared.
The cost of insuring corporate debt surged to a three-year high this week, with Woodside Petroleum Ltd. and Rio Tinto Group the worst performers in the Markit iTraxx Australia index. Australian stocks sank into a bear market on Wednesday as resource companies and banks extended declines.
The nation’s biggest lenders have been swept up in concerns about the ability of European banks to pay interest on their riskiest securities given weak earnings and the market slump. Deutsche Bank became the largest lender in at least four years to feel compelled to reassure investors and employees this week that it has enough funds to service that debt.
The average cost of credit default swaps for Commonwealth Bank of Australia, Westpac Banking Corp., National Australia Bank Ltd. and Australia & New Zealand Banking Group Ltd. climbed to the highest level in 2 1/2 years, while their share prices are all down by more than 5 percent this month.
“It seems having revenue and loan growth and a very compelling yield means little when there is a solvency issue in European banks and a consistent flattening of the U.S. yield curve leading to concerns over U.S. banks margins,” Chris Weston, a Melbourne-based analyst at IG Ltd. wrote in a report Wednesday. “The massive demand for protection in the shape of credit-default swaps is only exasperating the issue.”