Aussie Drop to 75 Cents Seen Halting Bond Gain: Australia Credit

The prospect that the Reserve Bank of Australia will get its wish for a weaker local dollar is casting doubt on bets for interest-rate reductions and prompting Kapstream Capital to steer away from sovereign bonds.

The Aussie will drop 7 percent to about 75 U.S. cents this year, extending its 8.3 percent decline in 2014, said Sydney-based Kumar Palghat, who co-founded fixed-income fund manager Kapstream after leaving Pacific Investment Management Co. in 2006. That will let RBA Governor Glenn Stevens, who said last month the economy needs a currency at that sort of level, hold the benchmark rate at a record low 2.5 percent this year, Palghat said, even as traders priced in at least one cut.

“The currency falling should help boost the export sector and is implicitly an easing of monetary policy,” Palghat, 53, who helps oversee the equivalent of $6.7 billion, said in an interview on Jan. 2. “For the RBA, the best-case scenario is for rates to be on hold and the Aussie dollar to come off.”

Kapstream is mostly buying corporate debt that offers higher yields than government bonds and benefits from an improving economy, amid signs that both business and mortgage lending are gathering pace. A lower currency would improve the competitiveness of manufacturers, weakening the case for interest-rate cuts that helped drive the 10-year sovereign yield to match a record low.

The Aussie dollar fetched 80.74 U.S. cents as of 4:30 p.m. in Sydney, after reaching 80.35 cents on Jan. 5, its weakest since July 2009. The 10-year yield fell to a record 2.61 percent.

Easing Bias

“The RBA will maintain an easing bias” this year, said Skye Masters, the head of interest-rate strategy in Sydney at National Australia Bank Ltd., the nation’s largest lender by assets. “One of the factors at play which would alleviate pressure on them to cut would be a lower currency. We know that’s a focus of the RBA at the moment.”

Australian bonds are rallying in tandem with gains in benchmark U.S. Treasuries, Masters said in a telephone interview yesterday. “Can the rally continue? Yes, it possibly can. Is it getting stretched? Yes it is.”

Analysts are forecasting the Aussie will be little changed by year-end at 80 cents, while 10-year yields will advance to 3.75 percent, separate surveys compiled by Bloomberg show.

Slower Growth

The economy has been struggling to cope with the end of a once-in-a-century resources boom and a slowdown in China, which purchases more than 35 percent of Australia’s overseas shipments. Growth unexpectedly slowed to 0.3 percent in the third quarter, the weakest in 18 months.

Data over the past two weeks signaled the Aussie dollar’s slump may be helping to spur growth. The trade deficit in November was A$925 million ($747 million), the statistics bureau said yesterday, narrower than the A$1.6 billion median forecast in a Bloomberg survey.

Loans to companies increased 4.6 percent in November from a year earlier, the RBA announced on New Year’s Eve. That was the most since March 2009. Outstanding home loans averaged a 5.4 percent increase in the two years to Nov. 30, compared with a 2.4 gain in corporate credit, the data showed.

The price for iron ore, which accounts for one-fifth of Australia’s export income, dropped by almost half in 2014, prompting economists from Deutsche Bank AG and Goldman Sachs Group Inc. to predict the RBA will cut rates this year.

Favoring Corporates

Kapstream favors bonds sold by companies, Palghat said. Declines in Treasury and Australian government yields last year defied forecasts for an increase as the Federal Reserve ended bond purchases. Japanese and European central banks have embraced monetary stimulus to ward off deflation.

Bonds in the Bank of America Merrill Lynch Global Broad Market Sovereign Plus Index yielded 1.24 percent yesterday, the lowest on record since the gauge started at the end of 1996. The similar corporate index’s yield was 2.55 percent.

“Sovereigns are borrowing at teaser rates,” Palghat said. “Central bank purchases have artificially lowered yields around the world.”

Australia’s bond yield premium over the U.S. will disappear for the first time since 2000 as the Fed begins to raise rates in the second half at a “measured” pace, he said.

The extra yield on Australia’s 10-year bonds over similar-maturity Treasuries shrank to 57 basis points on Dec. 31, the least since July 2006 and down from as much as 153 in March. It was at 72 today. The South Pacific nation’s sovereign debt returned 11 percent last year, Bloomberg AusBond indexes show.

“It’s hard to imagine another rally in government bonds unless there’s some massive dislocation from equities,” said Palghat.

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