RBA Cuts Augur Only Rising Sovereign Market: Australian Credit

Australian government bonds will be the only major developed sovereign market to provide capital gains to investors this year as the central bank cuts interest rates, analysts predict.

Benchmark 10-year notes in Australia will rise, pushing yields down from 3.48 percent today to 3.22 percent by June 30 before they rebound to 3.43 percent at year-end, according to the weighted average forecast in a Bloomberg News survey. Yields will advance for nine other developed nations, separate surveys show, including a 28 basis-point gain by Dec. 31 for U.S. Treasuries, 34 basis points for German bunds and 23 basis points for Japanese securities.

Societe Generale SA named Australian bonds among their top 10 assets over the next three years as they offer the highest yields for notes with AAA ratings from the three main credit assessors. Economists predict the Reserve Bank will cut borrowing costs to a record as a resources boom fades. Yields elsewhere will rise as accelerating global growth and diminishing concern about Europe’s debt crisis spurs investors to seek greater returns in riskier assets such as equities.

“In Australia, the economy is likely to remain quite soft over the next few years as the mining investment surge comes to an end,” said Warren Hogan, the chief economist at Australia & New Zealand Banking Group Ltd. “The theme for Aussie bonds is that they should outperform core sovereign markets.”

Investors who bought Australia’s 10-year bonds today would make a 3.5 percent return by year-end if the forecasts prove accurate, according to data compiled by Bloomberg. They would lose 0.5 percent on Treasuries and 1.4 percent on German bunds, the data show.

Yield Premium

The premium Australian 10-year sovereign paper offers over U.S. Treasuries of similar maturity narrowed to 1.51 percentage points yesterday from an almost four-month high of 1.67 on Dec. 14. It will end the year at 1.19 percentage points, based on strategists’ forecasts. The gap to bunds will shrink 0.39 percentage point to 1.48 and for Japan it will decline 0.28 to 2.44.

Yield forecasts for the U.K., Canada, France, Italy, New Zealand and Switzerland were also analyzed.

Auction Demand

Australian benchmark yields are little changed since Jan. 31 after they completed four months of increases, marking the longest stretch of bond-price declines since 2010. The 46-basis point advance in yields in that period has spurred demand at government bond auctions.

Investors bid for 4.27 times the July 2017 Australian federal securities offered Feb. 8, compared with an average so-called bid-to-cover ratio of 3.77 for 2012, according to data from the Australian Office of Financial Management.

“With very strong international participation in our bond market and the currency now off a little bit, you’re going to see increased demand from international investors for Australian bonds over the weeks ahead,” said Hogan. He predicts the RBA will lower its benchmark at least 50 basis points this year. The 10-year yield will drop to 3 percent by year-end, according to ANZ Bank.

Below Trend

Foreign investors held about 72 percent of bonds and bills issued by the Australian government in the third quarter, according to data compiled by Bloomberg from government sources.

Australia’s dollar, which rose 1.8 percent in 2012, traded at $1.0244 as of 2:47 p.m. in Sydney and touched a more than three-month low of $1.0242. The world’s fifth most-traded currency has retreated 1.4 percent this year.

Weak investment outside the mining industry, a soft labor market and high currency prompted policy makers to reduce their forecasts for economic growth and inflation last week.

The RBA predicted “below trend” 2013 growth of about 2.5 percent, compared with about 2.75 percent forecast in November. Consumer prices will rise 3 percent in the year to June 2013, compared with the 3.25 percent increase it had forecast three months earlier, the central bank said.

Policy makers said the global outlook has been “more positive in recent months” and China’s economy has stabilized. China is Australia’s largest trading partner followed by Japan and the U.S., government data show.

The gap between rates on Australian government bonds and inflation-linked debt shows traders expect a 2.71 percent annual advance in consumer prices over the next decade, down from a near 10-month high of 2.80 percent reached Feb. 4.

Rate Forecasts

RBA Governor Glenn Stevens will leave the overnight cash-rate target unchanged at 3 percent on March 5 and lower it 0.25 percentage point to a record in the second quarter, according to the median forecast of 29 economists surveyed by Bloomberg.

Traders see a 57 percent chance of a March cut, with an 87 percent chance the rate will be 2.75 percent or lower by June, according to swaps data compiled by Bloomberg.

Australian home-loan approvals fell in December for a third month and the proportion to first-home buyers slumped to an 8 1/2-year-low, government data yesterday showed, as central bank interest-rate cuts failed to lure buyers into the market

Stevens has lowered the benchmark by 1.75 percentage points since November 2011.

“From a valuation perspective we like the Australian economy and the bonds,” said Craig Veysey, head of fixed income at Sanlam Private Investments Ltd. in London, a unit of Sanlam Group, which oversees $72 billion. “In some of the AAA areas, like Australia, there have been some relatively interesting yield rises and we are considering allocating to those areas over the course of the coming weeks and months.”

‘Good Value’

Investors pared holdings of the safest assets in January as better economic prospects for the U.S. and a stabilization in Europe’s debt crisis buoys the appeal of riskier investments. A Merrill Lynch broad sovereign market index fell 0.5 percent last month compared with a 5 percent gain in the MSCI World Index of equities. Australia’s 10-year bond yields climbed 0.18 percentage point last month, the biggest advance since February 2012.

Bonds are back in favor this month after a Jan. 30 report showed the U.S. economy unexpectedly contracted in the final three months of last year. Australian government bonds returned a loss of 0.4 percent in 2013, the smallest decline among the eight nations with stable AAA ratings from Standard & Poor’s, Moody’s Investors Service and Fitch Ratings. Canada, Denmark, Norway, Sweden, Singapore, Switzerland and Finland are the others.

“We see good value in Australian government bonds,” said Patrick Legland, Paris-based global head of research at Societe Generale, in a Feb. 1 phone interview. “Australian bonds are a very good hedge,” against a possible slowing in growth in China and the wider Asian region, he said. Rates will remain at low levels and may decline, the bank predicts.

Before it's here, it's on the Bloomberg Terminal.