- Proportion of sovereign debt held offshore has fallen to 59%
- Currency forecast to fall back after climbing 5.4% this year
Australia’s government could do with a weaker currency to help lure back foreign bond buyers and provide a boost to demand as it ramps up sales.
The proportion of federal securities held by non-resident investors in the second quarter fell to just 59 percent, the least since 2009, according to official data. The face value of the government debt pile at the end of last week was A$433 billion ($332 billion) and budget estimates have it climbing to around A$500 billion by the end of June 2017.
While the Aussie dollar has climbed 5.4 percent this year to 76.78 U.S. cents as of 12 p.m. on Thursday in Sydney, it will slide to 72 cents by mid-2017, according to analyst forecasts compiled by Bloomberg. Sovereign bond prices are also predicted to fall, with the benchmark 10-year yield projected to rise to 2.04 percent from 1.85 percent over the same period, a separate poll shows. Such moves could help lure back buyers to a market that’s this year attracted the weakest average auction bidding since 2002.
“Aussie government bonds need to cheapen up or the currency needs to weaken in order to juice up overseas demand,” said Sally Auld, head of fixed-income and currency strategy for Australia at JPMorgan Chase & Co. She said the Aussie is “far too high” based on the differential between local and overseas interest rates and that a possible drop in iron ore prices could also provide a “headwind” to the currency.
The Australian dollar is on course to notch its first annual gain since 2012, having started the year at 72.86 cents. The yield on the 10-year federal note last month touched a record low 1.81 percent, while the premium it offers over equivalent-tenor U.S. securities shrank to as little as 22 basis points, the smallest gap since 2001.
The Aussie-U.S. spread was more than 2 percentage points in 2012 when the proportion of foreign ownership peaked at 76 percent amid a hunt for yield and diversification by reserve managers. Since then, repeated blowouts in the budget deficit have led to a near doubling of the amount of sovereign securities outstanding as revenue has slipped and successive governments have struggled to rein in spending. The uptick in bond supply has seen the ratio of foreign ownership ebb for eight consecutive quarters.
The softening of demand is evident at the regular bond tenders held by the Australian Office of Financial Management. Buyers at non-inflation linked bond auctions in 2016 have submitted bids to buy an average 2.8 times the amount of debt on offer at each sale, the lowest mean ratio since 2002, AOFM data show. Wednesday’s A$1 billion sale of 2027 bonds was covered just 1.59 times, the slackest demand in three years.
While data from the funding arm shows the total value of securities held by offshore buyers nudged up 0.3 percent to A$285.1 billion in the second quarter of 2016, that’s less than the 2.4 percent capital gain delivered by the rallying market over the same period, according to the Bloomberg AusBond Treasury Index. Last quarter was the first time foreigners were net sellers of the securities since 2012, National Australia Bank Ltd.’s Alex Stanley said.
“With ongoing bond supply, the Australian dollar nearer to the top of its range and the Aussie-U.S. 10-year spread historically tight, foreign demand could remain subdued in the near term,” the Sydney-based interest rate strategist said. “The Australian dollar has scope to fall. That view partly depends on the U.S. Fed raising rates in December. A far enough fall in the currency from current levels could ultimately support foreign demand for Australian government securities.”
Futures are pricing in about a one-in-two probability of an increase in U.S. borrowing costs by the end of the year, while the swaps market shows there’s is a better than even chance of rate reduction by the Reserve Bank of Australia by the end of March. That policy divergence is expected to further compress the yield spread between the Australian benchmark bonds and the U.S. 10-year paper. The premium is predicted to slide to 17 basis points by mid-2017, based on Bloomberg surveys.
“Australian government bonds will need to cheapen in order to attract increased demand,” David Plank, a macro strategist at Deutsche Bank AG in Sydney wrote in a research note on Tuesday. “We don’t think this cheapening will be via higher rate spreads to other markets, however. Indeed, we still see downward pressure on rate spreads over time. We think the needed price adjustment will occur via a weaker Australian dollar.”