Bonds ‘Swamped by Fear’ in Most Volatile Weeks on Record: Australia Credit
The difference between daily high and low prices on three- year government bond futures exceeded 19 basis points for a 10th-straight trading day, the first time that has happened since Bloomberg began compiling the data in 1989. The daily fluctuation for 10-year contracts exceeded 32 basis points twice this month, a swing seen on 10 days since 2000, the data show. Corporate bond risk surged the most in more than a year on Aug. 11, a day after posting its biggest drop since June 2010, according to CMA.
“We’ve seen fundamentals and associated valuations get swamped by fear, uncertainty and illiquidity,” said Damien McColough, head of fixed-income research in Sydney at Westpac Banking Corp., Australia’s second-largest lender. “If you made money in the morning and held the position you’ve lost it in the afternoon and that contributes to smaller positions, less risk on board, high uncertainty and a general morale in financial markets that is very, very low right now.”
The value of the global bond market has increased by $295 billion this month while more than $5 trillion has been wiped off equity markets as Standard & Poor’s downgraded U.S. debt for the first time, riots swept across Britain and Europe’s budget crisis deepened. While Australia’s central bank considered lifting borrowing costs on Aug. 2 to control inflation, traders are betting on more than one percentage point of rate cuts by year-end, cash-rate futures show.
Three-year bond futures for September delivery fell nine basis points to 96.13 as of 11:09 a.m. on the Sydney Futures exchange, after rising as high as 96.30 and touching as low as 96.09. The contracts fell 10 basis points in the week ended Aug. 12, after climbing by 71 the previous week. Ten-year contracts fell 6.5 basis points, paring some of their 37.5 basis-point surge over the past two weeks.
Bond investors bet last month that Australia’s central bank would keep rates at the highest of any developed economy after statistics bureau data on July 27 showed inflation was faster than economists forecast. Consumer prices rose at an annual pace of 3.6 percent, the most since 2008, the data showed.
Since then, S&P lowered the U.S. government’s credit rating to AA+ from AAA and the European Central Bank was forced to buy Spanish and Italian government debt to stem a bond-market rout. Australian cash-rate futures, which showed a 94 percent chance on July 28 that the RBA would keep its benchmark unchanged for the rest of the year, now indicate the central bank will reduce borrowing costs by at least 100 basis points from 4.75 percent.
Strategists at JPMorgan Chase & Co.’s Australian unit said its trading portfolio lost money speculating that the price of the December cash-rate future would drop, according to a research note published Aug. 12. They had anticipated a decline in the contract as the market started to price in higher yields.
“De-risking and potential for risk aversion suggests that volatility and large intra-day ranges may persist for some time yet,” Sally Auld, a JPMorgan interest-rate strategist, said in the note. “We remain cautious on markets and recommend minimal risk in the current environment.”
Nouriel Roubini, co-founder and chairman of New York-based Roubini Global Economics LLC, said last week the U.S. was heading into a double-dip recession and the ECB sought to halt debt-crisis contagion from spreading to Italy and Spain, the region’s third- and fourth-largest economies.
The European debt crisis that began in Greece in late 2009 has triggered 365 billion euros ($522 billion) in emergency bailout loans, exposed cracks in the euro’s architecture and rattled markets around the world. U.S. President Barack Obama said Aug. 11 that political gridlock in Washington has shaken the confidence of investors and the public after the downgrade by S&P on Aug. 5.
The rally in Australian government bonds over the past month hasn’t matched the surge in Treasuries, as investors sought the safety of the world’s deepest debt market.
The extra yield Australian 10-year notes offer over similar-maturity Treasuries was 223 basis points today after widening to this year’s high of 248 on Aug. 10. The Australian 10-year yield rose seven basis points to 4.50 percent, rising from the lowest level since April 2009.
The gap between yields on Australian government bonds and inflation-indexed notes shows investors estimate consumer-price gains to average 2.67 percent for the next five years, the highest inflation expectations among eight developed markets tracked by Bloomberg. Similar U.S. notes show predictions for 1.8 percent annual price increases.
The Reserve Bank will cut its benchmark borrowing rate from 4.75 percent by the end of the year, according to four economists out of 20 surveyed by Bloomberg News on Aug. 11. Ten expect it to remain unchanged, while six are forecasting an increase to 5 percent, the survey shows.
“We do not expect the RBA to ease simply because markets have been volatile,” Deutsche Bank AG economists said in an Aug. 12 note. “Our argument is that we think markets have moved sufficiently far to have real economy implications.”
Australia’s jobless rate unexpectedly rose to an eight- month high in July as hiring stalled, prompting Goldman Sachs & Partners Australia Pty to predict as many as two rate cuts this year. Unemployment jumped to 5.1 percent in July from 4.9 percent a month earlier, the first increase since October, the statistics bureau said Aug. 11.
“The shift in tone of the July employment report, in concert with the sharp deterioration in business and consumer surveys, is material new information for policy makers,” Goldman Sachs economists David Colosimo and Tim Toohey wrote in a report after the data was released, predicting 25 basis-point cuts each in September and November. A basis point is 0.25 percentage point.
The RBA will publish minutes of its Aug. 2 board meeting tomorrow, the same day euro-zone gross domestic product figures are released and German Chancellor Angela Merkel and French President Nicolas Sarkozy plan to meet in Paris to discuss the region’s crisis.
The market value of Bank of America Merrill Lynch’s Australian Governments Index has risen A$3.4 billion ($3.5 billion) this month to A$161 billion. An index of the nation’s corporate bonds has increased by A$723 million to A$73 billion, the data show. The nation’s benchmark stock index has dropped 6.2 percent to A$1.24 trillion between July 29 and Aug. 12.
The cost of insuring Australian corporate bonds from default surged, according to traders of credit-default swaps. The Markit iTraxx Australia index jumped 21.5 basis points last week to 156.1, according to prices from CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market.
Australian sovereign debt has produced gains of 9.1 percent this year, the best returns after New Zealand among 20 developed markets tracked by the Merrill Lynch indexes.
The Australian dollar also swung between gains and losses last week, with three-month implied volatility jumping to a 13- month high of 17.43 on Aug. 9, when the currency dropped below parity with the greenback for the first time since March 21. The so-called Aussie, the world’s fifth-most traded currency, rose 0.7 percent to $1.0424 today, after reaching a post-float high of $1.1081 following the July 27 inflation data.
“As markets are so volatile you can go from underperforming to overperforming and back again very quickly,” said Mat McCrum, investment director at Melbourne-based Omega Global Investors Pty, which manages A$1 billion. “I think the whole investment community is a bit weary of the volatility and shell shocked.”