RBA’s Cuts Shrink Yield Gap as Fed Taper Looms: Australia Credit

Australia’s benchmark bond yield is offering the smallest premium over U.S. notes in 11 months as the sharpest predicted growth slowdown in four years spurs bets on further interest rate cuts.

The 10-year rate was 3.22 percent, compared with 1.95 percent for similar-dated Treasuries, the narrowest since June 4. The gap reached 1.22 percentage points on May 17, the least since November 2008. Australia’s dollar sank by the most among major peers this month amid concern demand for its commodities will weaken as growth slows in China.

Reserve Bank of Australia Governor Glenn Stevens indicated May 7 he has scope for further reductions after lowering the key rate to a record 2.75 percent. Some U.S. Federal Reserve policy makers have said the bank may begin to slow its $85 billion in monthly bond-buying amid signs the economy is gaining strength.

Australia’s central bank “will continue to ease,” said Yusuke Ito, a bond investor at Tokyo-based Mizuho Asset Management Co., which oversees the equivalent of $32.3 billion. “China is slowing. They had been depending on external demand, but they’re changing to more dependence on consumption, which is going to be negative for Australia.”

Swaps traders are betting on a 59 percent chance the RBA will cut borrowing costs again within three months.

Outlook Weakens

Policy makers lowered their inflation outlook this month, predicting consumer prices will rise 2 percent in the year to December 2013, compared with an earlier estimate of as much as 3 percent. The RBA predicted 2013 growth of about 2.5 percent. That’s more than one percentage point slower than 2012, the sharpest decline in real growth since 2009.

The Australian government also forecast slower growth last week when it released federal spending plans for the fiscal year starting July 1. Treasurer Wayne Swan is seeking to raise more money from businesses after lower tax revenue led the government to scrap plans to return the budget to surplus this year.

The slowdown in activity comes as a record mining investment boom peaks, while the services, construction and manufacturing industries deteriorate under pressure from the Australian dollar’s strength over the past four years.

Investors are also concerned about the impact of a slowing in China, Australia’s largest trade partner. Iron ore, the South Pacific nation’s most valuable commodity export, slumped into a bear market last week as reports showed China’s April industrial output trailed estimates and fixed-asset investment slowed. China is the world’s largest buyer of iron ore and Australia is the biggest exporter of the raw material.

Aussie Dropping

The Aussie dollar, the world’s fifth most-traded currency, dropped 6 percent since April 30 to 97.48 U.S. cents as of 11:11 a.m. in Sydney, poised for its steepest monthly decline in a year. The currency is still 29 percent higher than its average of 75.60 cents since exchange-rate controls were scrapped in 1983.

Bank of America Corp. cut its estimate on China’s 2013 economic growth to 7.6 percent from 8 percent on May 15, citing sluggish external demand.

“The Aussie is a good option to express a weaker China growth story,” said Greg Gibbs, a Singapore-based senior currency strategist at Royal Bank of Scotland Group Plc. “Also the mining boom has ended in Australia and that’s naturally going to put a significant weight on the economy and create significant risks going forward.”

Weaker Economy

In Australia, government data released this month showed retail sales and building approvals unexpectedly dropped in March, while a private report revealed that business confidence dropped to -2 in April with sentiment in the mining industry at its lowest since the global financial crisis. A May 9 report showed unemployment unexpectedly declined.

“The outlook for non-mining business investment remains relatively weak over the next few months,” the RBA said in its monetary policy statement in Sydney on May 10. “The approaching peak in resource investment, the high level of the Australian dollar and ongoing fiscal consolidation are all likely to weigh on growth over the next year or so, while at the same time the low level of interest rates is helping to support demand.”

The nation’s sovereign bonds have benefited, returning 1.8 percent to investors this quarter as of May 17, the best performance among 11 nations that hold the AAA grade from all three main ratings companies, according to Bank of America Merrill Lynch indexes. U.S. Treasuries are little changed this quarter, the data show.

Tapering Debate

The yield on U.S. 10-year notes climbed as high as 1.98 percent last week, the most since March 15, amid signs the world’s largest economy is absorbing the impact of tax increases and spending cuts. Sales at U.S. retailers unexpectedly advanced in April and confidence among the nation’s small businesses climbed to a six-month high, while housing starts and industrial production fell.

U.S. officials are debating whether the economy is strong enough for them to curtail their asset purchases.

Fed Bank of San Francisco President John Williams said May 16 the central bank within months may begin slowing the pace of its monthly bond-buying amid clear signs that the labor market has improved. Williams, who doesn’t vote on policy this year, was one of the first Fed officials to advocate that the central bank buy bonds without setting a limit on the duration or total for such purchases.

Federal Reserve Governor Sarah Bloom Raskin said income inequality and government cutbacks may slow economic growth for years.

“In the U.S., the Federal Reserve will probably be the first central bank to stop buying bonds as the economy improves,” said Kazuaki Oh’e, a debt salesman in Tokyo at CIBC World Markets Japan Inc., a unit of Canada’s fifth-largest lender. The yield gap between Australia and the U.S. “will probably continue to shrink.”

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