Bundesbank Enters as Japan’s Funds Dump Bonds: Australia Credit

Central banks are taking over as leading buyers of Australia’s bonds after Japanese investors sold the securities at the fastest pace in at least eight years.

Investors from the Asian nation with the region’s lowest benchmark yields capped three months of selling in January, when they offloaded a net 439.3 billion yen ($4.6 billion) in Australian dollar debt, the most since 2005, the Tokyo-based Ministry of Finance said March 8. Offshore investors bought A$13.1 billion ($13.4 billion) of Australian fixed-income securities, the world’s highest-yielding AAA debt, in the fourth quarter including A$4.5 billion of sovereign paper, government data released in Sydney last week showed. The Bundesbank said last week the securities will play a role in its reserves.

“What you’re seeing is sovereign buying in the Aussie market filling the gap left by Japanese investors and our belief is that a lot of that is coming from the European central banks,” said Damien McColough, head of fixed-income research at Westpac Banking Corp. in Sydney. “Sovereigns are still buying government bonds but they’re also buying supra-national and state debt at a faster pace than they were previously.”

Central banks managing as much as $7 trillion, including those in Germany, France and China, are holding Australian dollars, according to data compiled by Bloomberg and documents released by the nation’s Reserve Bank. At the same time, prospects for Japan’s return to growth buoyed sentiment among investors there, driving them away from top-rated Australian debt into riskier assets such as equities.

Bundesbank Buying

“As a central bank, the Bundesbank manages foreign-currency reserves primarily with safety and liquidity in mind,” Germany’s central bank said March 8 in an e-mailed statement. “The Bundesbank has a very long-term investment strategy. The Australian dollar will in future complement the U.S. dollar and Japanese yen, which have already long been used as reserve currencies.”

Reserve managers poured funds into Australia as slow growth and mounting debt in the biggest developed markets including the U.S., U.K. and Japan spurred a hunt for alternative havens. Australia, with A$267 billion in securities outstanding, is one of only 10 nations that hold AAA scores from all three main credit rating companies. Its bond market is the largest among top-graded sovereigns after Germany, Canada and the Netherlands.

“The little Aussie bond market is the fourth-biggest AAA in the world, and the size and risk characteristics of the market, the liquidity of the currency and exposure to China all remain in place,” said McColough. “There is a sense that the worst of the Japanese selling is over and there’s the potential for them to get back in.”

Yield Advantage

The Aussie was at 98.28 yen as of 5:18 p.m. in Sydney, after reaching 99 yen on March 8, the highest level since August 2008. The Australian dollar advanced 0.3 percent last week to $1.0236, extending its record eight-month stretch above parity with the greenback. Investors may consider re-entering the market if the Aussie were to decline to between 85-90 yen, said McColough.

“Japanese investors started taking profit as the yen weakened,” said Yoshisada Ishide, who manages the $10.2 billion Daiwa SB Short-Term Australian Dollar Bond Open Fund. “Investors concentrated their holdings in the Australian fixed income market for safety when market sentiment was negative. Now, people are starting to diversify their assets and going into other markets such equities.”

Ishide said he prefers to hold debt by corporate issuers, state governments and foreign borrowers over sovereign notes to “enhance” his fund’s performance.

Higher Rates

Australia’s 10-year bonds yield at least 165 basis points more than rates in the three larger AAA markets. The securities offered a 6 percent return when adjusted for price swings over the three years ended Dec. 31, the most among nine top-rated markets covered by indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies. Treasuries offered a risk-adjusted gain of 4.1 percent.

The South Pacific nation’s bond yields have climbed after the Reserve Bank of Australia left interest rates unchanged at 3 percent last week and signaled previous cuts are starting to have an impact.

The benchmark 10-year bond yield reached 3.61 percent today, the highest level since May. Japan’s 10-year rate was at 0.66 percent in Tokyo today after reaching an almost 10-year low of 0.585 percent on March 5 amid speculation the Bank of Japan will buy longer-dated securities.

Growth Prospects

Better prospects for growth have spurred investors to purchase higher-yielding Aussie debt including the bonds of states, government-backed lenders and corporates.

The extra return investors demand to hold securities issued by Australian provinces and highly-rated foreign-based borrowers like Kreditanstalt fuer Wiederaufbau, Germany’s state-owned development bank, was at 64 basis points on Feb. 25, the least since August 2011. The premium investors demand to hold corporate bonds declined to 144 on Feb. 18, the lowest since December 2007.

Bold BOJ

“Japan is just in an unusual situation at the moment with the market anticipating bold steps from the BOJ,” said Kieran Davies, chief economist at Barclays Plc in Sydney. Investors there have become “far more adept at trading in and out of the Australian bond market, depending on what the yen cross rate is doing.”

Bond inflows have supported the so-called Aussie, the world’s fifth most-traded currency, which climbed 20 percent against Japan’s yen over the past six months.

Japanese investors held 13.98 trillion yen of debt denominated in Australian dollars as of the end of 2011, based on the latest figures available from the Bank of Japan. At the time, the figure was equivalent to A$178.1 billion compared with Australia’s sovereign bond market of A$210.3 billion, according to data compiled by Bloomberg.

Japan’s Nikkei 225 Stock Average last week rose above the level it was at before Lehman Brothers Holdings Inc. collapsed, erasing losses acquired since the company’s bankruptcy froze credit markets and sent investors in search of refuge assets.

The benchmark Japanese 10-year yield dropped to 0.585 percent on March 5, the lowest since June 2003. Japan’s Cabinet Office said March 8 gross domestic product rose an annualized 0.2 percent in the three months through December, rebounding from a contraction in the previous period.

Japanese investors sold 1.09 trillion yen in Aussie-dollar bonds between November and January, more than twice the amount of net purchases in the first 10 months of the year, finance ministry data show.

“A large part of the reallocation toward Australia has happened but if you get further increases in reserves growth you will see central banks participating in the Australian market,” said Davies at Barclays. “The frenetic buying is behind us.”

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