Aussie Long-Bond Rally May Be Getting Long in the ToothBy
Annual government bond sales may reach A$100 billion, TD says
Bond rally jars with auction demand at lowest in 14 years
Australia’s long-bond rally may be getting a bit long in the tooth as risks mount from a surge in issuance and the prospect of higher U.S. interest rates.
While Australian sovereign securities due in a decade or more have delivered a 14 percent gain this year and the benchmark 10-year note remains near the record low 1.81 percent it touched last month, the market is showing signs of fatigue. Government bond auctions this year elicited the weakest average bid-to-cover ratio since 2002, according to official data compiled by Bloomberg.
With budget savings stymied and government revenues under pressure, annual sales of Aussie sovereign bonds could climb to A$100 billion ($75 billion), according to an estimate by TD Securities. Combined with higher Federal Reserve rates and uncertainty surrounding the limits of European and Japanese policy, such an influx could trigger an increase in longer-tenor yields even as the Reserve Bank of Australia’s record-low benchmark anchors shorter-term rates.
“There’s been quite a lot of issuance by Australia,” said Tony Morriss, an interest-rate strategist at Bank of America Merrill Lynch in Sydney. “If anything, that should argue for the yield curve to steepen as there will be more and more focus on longer-dated issuance over time. The budget dynamics support the idea that curves can steepen over coming months.”
Increasingly attractive U.S. interest rates may help lure investors away from Aussie notes. The yield on Australia’s 10-year security will rise to 2.4 percent by the middle of next year, Bank of America predicts, while the average forecast in a Bloomberg survey of analysts is for it to climb to 2.05 percent. The spread between Australian two-year and 10-year rates is anticipated to widen from 37 basis points to 73 over the same period, according to the survey.
The probability that the Fed will increase rates at its Sept. 20-21 meeting has climbed to 34 percent from 18 percent at the start of August, according to futures data compiled by Bloomberg. The chance of an increase by year-end is 60 percent. The odds of a Reserve Bank of Australia cut this year are about two-in-five, swaps data indicate.
While the global rush into government bonds has shown little sign of reversing for now, the appeal of Australian bonds versus international peers is at risk of fading. The 10-year Aussie note, which yielded 1.85 percent as of 12 p.m. on Friday in Sydney, has seen its premium over equivalent U.S. paper shrink to just 27 basis points, near the lowest level in 15 years.
Excluding Japan, all of the world’s seven biggest developed economies are projected to register an increase in 10-year rates by the end of 2017, according to the average forecasts of analysts surveyed by Bloomberg.
That global rise in rates, coupled with increased Australian issuance, could take away some of the sheen from Australian paper. The government’s financing arm said in May that it will sell about A$90 billion of nominal bonds and at least A$3 billion on inflation-linked securities in the year to June 30, 2017. Since then, Treasurer Scott Morrison has struggled to win parliamentary support for budget savings measures designed to keep the debt pile in check. The amount of government securities outstanding stood at A$432 billion as of Aug. 26, official data show.
Demand at Australia’s bond sales in 2016 has dropped to the lowest level in 14 years. At auctions this year, investors have submitted bids to buy an average 2.83 times the amount of debt on offer, the lowest ratio since 2002, data from the Australian Office of Financial Management show. A A$1 billion sale of 2027 bonds in July was covered just 1.66 times, the least demand in three years.
While Australia’s volume of issuance hasn’t presented a problem thus far because of the “relentless” hunt for yield, there are questions over what impact higher global bond rates might have, TD Securities strategist Prashant Newnaha wrote in an Aug. 26 note.
“All of a sudden the funding task for the AOFM could become an issue and the headache could get worse if the market agrees with our estimates for issuance over the forward years to clock in at A$100 billion per year,” he said. “If so, this could weigh on the longer end” of the Australian curve.