Aussie Bond Bears Held Hostage by Draghi

  • Aussie 10-year yield is more than 10 times that of German bund
  • Analysts cut forecasts by 20 basis points in past month

Markets Brace for a Move by the ECB's Mario Draghi

If you want a steer on why Australian bond analysts have made their biggest cuts to yield forecasts in a year, look overseas to experiments by central bankers in Europe and Japan.

Mario Draghi has laid the groundwork for a more negative European Central Bank deposit rate on Thursday, even as more than $2.5 trillion of the region’s bonds already yield less than zero. Haruhiko Kuroda’s policies in Japan mean more than $5 trillion of government debt yields do the same. Analysts surveyed in February projected that Australia’s 10-year yield will end this quarter at 2.70 percent, down from a forecast of 2.90 percent in the previous month’s Bloomberg survey.

“With the anchors of negative Japanese government bond yields and very low German bund yields, it’s very difficult to see a material selloff in Australian bonds,” said Charles Jamieson, who has spent 15 years trading debt in Tokyo, New York, London and Sydney and in 2014 set up Melbourne-based fund manager Jamieson Coote Bonds. “The hunt for yield is alive and well.”

Spread Appeal

Jamieson says Australia’s 10-year yield is more likely to be under 2.50 percent at the end of March, with the level ranging between 2.25 and 2.65 percent through June 30 as the market absorbs first the ECB and then the Federal Reserve’s policy decisions. The Reserve Bank of New Zealand unexpectedly cut its key rate to a fresh record 2.25 percent Thursday and said further easing may be needed.

There are reasons to be bearish on Australian bonds after central bank Governor Glenn Stevens resisted lowering the benchmark below 2 percent last week and expressed enough confidence in the local economy to reduce bets on further easing.

Australia’s 10-year yield climbed four basis points to 2.60 percent as of 1:54 p.m. in Sydney on Thursday, 2.36 percentage points more than similar-maturity German bunds and 2.62 percentage points above their Japanese equivalents. The following charts show Australia’s yield advantage and the impact that can have on demand for the nation’s currency.

CHART 1: Australia’s 10-year bond yields are low by historical standards, averaging 2.71 percent in the past year compared with about 4.80 percent in the previous decade. That’s still a lot more than in other major developed countries where central banks have used unconventional policies to depress rates.

CHART 2: Low rates elsewhere means investors are drawn to Australian assets at times with market volatility is muted, driving up the Aussie. A trade-weighted index of the currency was at its strongest level since July this week as futures traders increased bets it would appreciate.

CHART 3: Borrowing in euros to buy Australian dollars generated the third-best return among 16 major exchange-rate pairs in the past month. “Monetary easing abroad is a complication for us,” central bank Deputy Governor Philip Lowe said this week. “Like everyone, we would welcome a slightly lower exchange rate” to help the economy, he said.

CHART 4: In a period of elevated volatility, Australia’s sovereign bonds also stand out as offering the highest yields among nations with the top grade from all three major credit rating companies.

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