Pimco Says Misguided Market Underestimates RBA: Australia Credit
Pacific Investment Management Co. says Australian debt markets are misguided to bet the central bank is almost done cutting interest rates, as the economy will struggle to cope as a resource investment boom fades.
“The big economic uncertainty arrives when the economy transitions from an investment destination to a production and export engine,” said Robert Mead, Sydney-based head of portfolio management at Pimco, which runs the world’s biggest bond fund. “This transition will not be smooth.”
Reserve Bank of Australia Governor Glenn Stevens will lower the overnight cash rate target to 2.75 percent from 3 percent by Dec. 31, according to the median forecast of 29 economists surveyed by Bloomberg News. Traders expect 31 basis points of cuts over 12 months, down from 56 basis points seen on Jan. 28, a Credit Suisse Group AG index based on swaps shows.
Pimco is investing in longer-dated swaps, state government bonds and high-quality corporate notes as markets, which had priced in an “unrealistic series” of rate cuts, are now probably not pricing in enough, said Mead. The fund manager, which oversees $2 trillion worldwide, expects the Australian economy to struggle toward the end of 2013 and early next year as growth moderates in China, the nation’s largest trading partner. The RBA predicted “below trend” 2013 growth of about 2.5 percent on Feb. 8, slowing from 3.5 percent last year.
Mining investment will likely peak this year and at a lower level than previously expected, RBA Assistant Governor Christopher Kent said Feb. 15. Chinese demand for commodities will grow “strongly” for some time though at a slower pace, he said.
“We estimate transition somewhere between fourth quarter 2013 and second quarter 2014, depending on projects being on time et cetera, so the growth uncertainty will increase over this period and the market will start to anticipate this uncertainty well in advance,” Mead said in response to e-mailed questions.
The extra yield 10-year swap rates offer over similar- maturity government debt was 52 basis points, compared with a 26 basis-point gap for three-year securities, Bloomberg data show. Pimco isn’t buying Australian sovereign debt, Mead said.
“The offshore bid for Australian assets was predominantly in Commonwealth Government bonds, so they became relatively expensive versus other, high-quality alternatives,” he said. “We are focused on the carry benefit of these assets in what we expect to be a fairly benign credit market for high quality borrowers,” Mead said with regard to swaps, state government and corporate notes.
Australian sovereign bonds fell 0.9 percent this year, Bank of America Merrill Lynch indexes show. That is the smallest loss among the eight nations that hold a stable AAA rating from all three of Fitch Ratings, Moody’s Investors Service and Standard & Poor’s. Securities issued by Australian states and territories declined 0.4 percent while corporate bonds have returned 0.3 percent, according to Merrill Lynch data.
Australia’s economic prospects remain dependent on mining with the RBA yet to see significant impact from its efforts to spur household and corporate spending through 1.75 percentage points of interest-rate cuts since November 2011.
Retail sales declined in the final three months of 2012, the longest stretch in 13 years, and home-loan and building approvals fell in December. A gauge of manufacturing weakened to a 3 1/2-year low in January and services contracted for a 12th month, Australian Industry Group reports showed.
Consumers remain cautious as the nation’s employers reduced full-time positions for a third month in January, the longest period of cuts since 2009.
“The Australian economy continues to slow and we believe Chinese growth will also moderate into the second half of 2013,” Mead said.
Australian growth will be about one percentage point slower this year, according to RBA forecasts, the biggest decline among Group of 10 currency nations after Japan. The world’s third- largest economy will expand 0.9 percent this year, compared with 1.98 percent in 2012, while Chinese growth will quicken to 8.15 percent from 7.8 percent in the previous year, Bloomberg surveys show.
There are indications that lower rates are starting to spur the economy, the RBA said, according to minutes of its February meeting released today. It reiterated that tame prices provide scope to ease further if needed.
The central bank said its reductions have “brought the average interest rate on outstanding housing loans to well below its longer-run average and only a little above its 2009 low.” Rates on small and large business loans were also close to their 2009 lows, it said.
A sentiment index for February jumped 7.7 percent to 108.3, a Westpac Banking Corp. and Melbourne Institute survey taken Feb. 4-8 of 1,200 adults showed last week. That was the strongest reading since December 2010 and the fourth-straight figure above the 100 level that indicates optimists outnumber pessimists.
“This adds further weight to our view that the soft patch in the Australian economy may now be behind us,” Paul Bloxham, chief economist for HSBC Holdings Plc in Sydney and a former RBA official, wrote in a research report on Feb. 13. “We maintain our non-consensus view that the RBA’s easing phase is done.”
Bloxham is the only economist among 29 polled by Bloomberg this month to predict a rate increase this year.
Prospects for slower growth have led analysts to predict Australia will be the only major developed economy where benchmark 10-year yields will remain little changed by the end of this year at 3.55 percent, from 3.59 percent today. Rates will climb 31 basis points for Treasuries, 27 basis points for bunds and 37 basis points for Japanese bonds, according to data compiled by Bloomberg.
The gap between Australian and U.S. 10-year yields narrowed to 1.58 percentage points from an almost four-month high of 1.67 on Dec. 14. It will end the year at 1.23 percentage points, should the consensus forecasts prove accurate.
“With the mining investment cycle passing its peak, plus the elevated Australian dollar, there remains a limit in terms of how high Australian yields can go, especially given the retracement we have seen since fourth-quarter 2012,” Mead said. “The starting level of real yields and the economic fundamentals will eventually lead to outperformance of Australian bonds versus other developed markets.”
The Aussie dollar, the world’s fifth most-traded currency, declined 0.6 percent this year to $1.0329 as of 12:47 p.m. in Sydney.
The gap between rates on Australian government bonds and inflation-linked debt shows traders expect a 2.76 percent annual advance in consumer prices over the next decade.
Governor Stevens left the nation’s benchmark rate unchanged on Feb. 5 and said the inflation outlook created room to “ease policy further.” Consumer prices will rise 3 percent in the year to June 2013, down from a previous forecast for 3.25 percent, the central bank said Feb. 8. Policy makers aim for underlying average inflation of 2 to 3 percent a year.
“The RBA has not finished their cycle, unless of course we see a significant drop in the Australian dollar or an abandonment of fiscal discipline,” Mead said.
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