Hedge Funds Spur Record Australian Bond Trade: Australia Credit

As central bankers warn financial markets may be headed for a bumpy ride, buyers of Australia’s bonds can take comfort from the liveliest trading on record.

Turnover in government bonds grew 5 percent to A$1.05 trillion ($908 billion) during the year ended June 30, according to the Australian Office of Financial Management annual report Oct. 31. Hedge fund trading jumped 11 percent. Sovereign bonds outstanding climbed almost 25 percent to A$290 billion, making it easier for investors can buy or sell in a crisis.

Central bankers from the Federal Reserve’s Janet Yellen to Bank of England Governor Mark Carney said in Paris last week that financial-market turbulence may rise when they withdraw monetary stimulus. A liquidity squeeze sent prices surging Oct. 15 in U.S. Treasury securities, supposed to be the deepest market in the world. Benchmark 10-year yields plunged as much as 34 basis points. Yields dropped about half as much in Australia.

“It’s a totally liquid market,” said Hideo Shimomura, the chief fund investor at Mitsubishi UFJ Asset Management Co. in Tokyo, which manages the equivalent of $69.5 billion. “We can buy and sell in large size,” he said by telephone Nov. 7.

The market can easily absorb a large trade, which would be for A$50 million to A$100 million, he said. In Treasuries, a large trade would be $500 million to $1 billion, which is also easy to execute, he said.

Futures Trading

Turnover in Australian 10-year futures contracts surged 20 percent and rose 1 percent for three-years, according to the AOFM report. The three-year future is among the 10 most-traded interest-rate futures products in the world, the AOFM said.

The nation’s government bonds returned 7 percent this year, beating the 5.1 percent in the U.S., Bloomberg indexes show.

In Treasuries, the biggest bond market in the world at $12.4 trillion, a rush for securities on Oct. 15 sent prices surging as global financial markets from Asia to Europe buckled.

Ten-year U.S. yields tumbled to 1.86 percent, the lowest level in more than a year, from the day-before close of 2.20 percent. The Bank of America Merrill Lynch MOVE Index of volatility in the Treasury market surged to the highest level in a year.

Once bond markets opened the next day in Australia, 10-year yields also tumbled to a one-year low, with an 18-basis-point decline.

October Panic

“It’s liquid enough” in Australia, said Kei Katayama, who trades the nation’s debt at Daiwa SB Investments Ltd. in Tokyo. There was a buying “panic” in October, he said. “That is not defined as an illiquid market. That happens from time to time,” he said in a telephone interview on Nov. 5.

Daiwa SB, which manages the equivalent of about $43 billion, hasn’t had trouble obtaining bonds in Australia, he said.

Non-residents owned about 70 percent of Australia’s sovereign securities, with the figure little changed in recent years, according to data compiled by the AOFM.

Australia offers a top level AAA debt grade from all three major ratings companies and 10-year yields that were 3.30 percent as of 1:11 p.m. in Sydney, about 1 percentage point more than same-maturity U.S. Treasuries. Demand for the South Pacific nation’s debt has narrowed the spread from more than 1.5 percentage points as recently as March.

Policy Fallout

Yellen and William C. Dudley of the Federal Reserve, the BOE’s Carney and Mexico’s Agustin Carstens all used a Paris conference last week to talk about potential fallout amid the eventual shift from record-low interest rates used to revive growth since the global financial crisis struck in 2008.

“Normalization could lead to some heightened financial volatility,” Yellen told the gathering. Carney said “the transition could be bumpy.” Dudley said he expects the Fed to raise interest rates next year.

Hedge fund trading in Australian government debt increased by 11 percent in the 2013-2014 period, according to the Australian Financial Markets Association.

Trading by foreign central banks and government-sponsored authorities declined by 48 percent, based on the group’s annual report. Fund managers increased their activity by 22 percent.

“There continues to be a healthy interest in Australia,” said Peter Jolly, the head of market research at National Australia Bank Ltd., the nation’s largest bank as measured by assets. “That’s against the backdrop of generally lighter liquidity in just about all markets globally, be they foreign exchange, equities, bonds,” he said in a telephone call Nov. 3.

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