Budget rate-expectaion swings since 2009 fade
The biggest swings in Australian interest-rate expectations in more than two years have left bond investors concluding the central bank will hold borrowing costs to sustain economic growth amid quickening inflation.
The implied yield on September interbank cash-rate futures climbed 16 basis points this week to 4.56 percent, the biggest two-day advance since Oct. 7, narrowing its discount to the central bank’s 4.75 percent benchmark. Traders of interest-rate swaps pared bets on a September reduction in the policy rate since those wagers peaked Aug. 5 at the end of the biggest weekly change since Feb. 6, 2009.
Australian government bonds, the developed world’s second- best performers this year, extended the biggest rally since 2008 this month even after policy makers considered increasing benchmark borrowing costs with underlying inflation poised to breach the RBA’s 3 percent cap. Governor Glenn Stevens must weigh price gains against financial turmoil that may deepen the worst slump in consumer confidence since 2009.
“Things are just settling down after the last two weeks where we’ve seen a pretty big adjustment to expectations surrounding growth both in Australia and globally,” said Simon Doyle, who oversees the equivalent of $6 billion in assets as head of fixed income and multi-asset at Schroder Investment Management Australia Ltd. in Sydney. “We’re still some way away from the point where the RBA feel they can ease policy.”
Rate Rise Considered
RBA policy makers looked past the strongest annual inflation in 2 1/2 years to keep the overnight cash rate target unchanged for an eighth meeting on Aug. 2, according to minutes of the gathering published yesterday. The central bank decided against a rate increase as contagion from Europe’s sovereign bond sell-off spread to Italy and Spain and the U.S. government’s struggles to avert a default roiled markets.
The MSCI World Index of equities is headed for an 8.3 percent drop in August, extending three months of declines, after tumbling 5.1 percent Aug. 8 in the biggest slide since December 2008. The yield on the September future for the RBA cash rate fell to 4.29 percent on Aug. 9.
Following Standard & Poor’s Aug. 5 downgrade of the U.S. credit rating from AAA, traders increased bets the RBA would be forced to slash rates as it did after the collapse of Lehman Brothers Holdings Inc. in 2008 when the benchmark was cut from 7.25 percent to 3 percent in the space of eight months.
Government bond yields of all maturities held below the cash rate yesterday after falling to that relative level this month for the first time in more than two years.
Expectations Fluctuate
Expectations for the next RBA move shifted 204 basis points in the week ended Aug. 5, the biggest change since the five days to Feb. 6, 2009, according to a Credit Suisse Group AG index. The gauge moved from indicating an 8 percent chance the RBA would raise rates at its next meeting to a certainty that the next move would be a reduction of 25 basis points and a better than 90 percent chance for a 50-basis-point cut.
“The case against tightening at this meeting was that the downside risks to demand had probably increased, as a result of the acute uncertainty in global financial markets,” the RBA minutes showed yesterday. “This in turn could weaken the outlook for demand relative to the central forecast and, over the medium term, dampen the inflation outlook.”
Volatility in Australia’s bond market reached record highs this month as investors tried to reconcile a global equities slump with the RBA’s talk of higher borrowing costs. The difference between daily high and low prices on three-year government bond futures was at least 20 basis points for 10 straight trading days through Aug. 15, the first time that has happened since Bloomberg began compiling the data in 1989.
Since the RBA meeting, government and private reports have shown weaker employment and consumer confidence, intensifying concerns that the Australian dollar’s climb to a record high is damaging those industries not directly tied to the nation’s biggest mining boom in 150 years.
Qantas Job Cuts
Unemployment last month jumped for the first time since October 2010 to 5.1 percent, a government report showed Aug. 10. Qantas Airways Ltd., Australia’s largest airline, yesterday announced 1,000 job cuts and said it will switch the company’s focus to Asia, forming a Japanese budget carrier and an Asia- based full-service unit.
Australian government bonds have returned 8.5 percent this year, including reinvested interest, the best performance after New Zealand among 20 developed markets tracked by Bank of America Merrill Lynch indexes.
Price Pressures
Ten-year bond yields declined five basis points, or 0.05 percentage points, to 4.51 percent yesterday. The extra yield over similar-maturity Treasuries was at 223 basis points, down from this year’s high of 248 on Aug. 10. The three-year yield fell seven basis points to 3.81 percent after reaching 3.41 percent on Aug. 9, the lowest level since April 2009.
The difference between three- and 10-year government bond yields rose as high as 81 basis points on Aug. 5, the most since Feb. 23, 2010, as investors sought a larger premium to own longer-dated debt amid concern inflation may accelerate.
Global uncertainties are being balanced by a record mining investment boom in Australia and “still work in favor of stronger growth and inflation at the top of the target range in the medium term,” said Stephen Roberts, a senior economist at Nomura Australia Ltd. in Sydney. “Our view is that the RBA could hold rates for several months and that it is likely to be early 2012 before it changes its policy bias.”
Stevens’s decision to leave the developed world’s highest benchmark rate unchanged this month came after a government report showed the RBA’s two preferred measures of annual inflation accelerated to 2.7 percent in the second quarter, compared with a gain of about 2.3 percent in the first quarter. Consumer prices rose at an annual pace of 3.6 percent, the most since 2008, the data showed.
Australian Dollar
The report pushed the Australian dollar to $1.1081 on July 27, the strongest level since exchange controls were scrapped in 1983. It also prompted the RBA’s board to consider tightening monetary policy, the minutes showed.
The Aussie dollar, the world’s fifth most-traded currency, has climbed 16 percent over the past year and traded at $1.0434 as of 4:41 p.m. in Sydney yesterday, compared with an average of 73.84 U.S. cents since 1983.
Growth, Price Forecasts
The RBA on Aug. 5 forecast growth in 2011 will average 2 percent, down from its May 6 estimate of 3.25 percent, while gross domestic product in 2012 will accelerate 4.5 percent, stronger than the prior estimate for a 4.25 percent expansion.
Consumer prices will rise 3.5 percent in the year through to the final quarter of 2011, from a previous prediction of 3.25 percent, and core inflation will quicken to 3.25 percent from 3 percent, it said. The RBA said underlying inflation will remain “relatively high” in 2012 and 2013.
The gap between yields on Australian government bonds and inflation-indexed notes shows investors estimate consumer-price gains to average 2.64 percent for the next five years, up from this year’s low of 2.59 percent reached Aug. 5. That is the highest inflation expectation among eight developed markets tracked by Bloomberg.
“The market pricing generally is very much on the fear side and I’d expect to see an improvement, albeit it will be erratic,” said John Honan, Sydney-based head of research and chief economist at Ausbil Dexia Ltd., which oversees about $14.5 billion. “The rates market has gotten ahead of reality here.”
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