We published a bullish view on Australian Bonds today on Seeking Alpha. Below are some excerpts:
- Australian Treasury Indexed Bond (TIB) markets are now pricing in inflation to average just 12 basis points per year for the next decade, despite the decline in the AUD.
- Despite this, nominal government bond yields have actually edged up since the crisis began, with the 10-year TIB now yielding 78bps.
- With full control over its own monetary policy, the Reserve Bank of Australia is likely to expand QE until real yields head back into negative territory.
- In U.S. dollar terms, the Bloomberg Australian 10+ Inflation-Linked Bond Index has fallen 30% in just two weeks and now provides a strong opportunity for those looking to try to pick a bottom in the Aussie dollar.
“It looks as though foreign investors, which hold ~60% of Australian government bonds, have dumped them in favour of U.S. dollar, putting simultaneous upside pressure on yields and downside pressure on the currency. We expect investors to return to the Australian bond market to take advantage of the 0.8% real default-free yield. Indeed, despite the sharp rise in Australia credit default swaps over the past month, default risks are negligible in our view as Australia’s external liabilities are overwhelmingly in the form of local currency.”
“With full control over its own monetary policy, the Reserve Bank of Australia is unlikely to sit idle while real bond yields remain at their current tight levels, particularly with the overleveraged banking system heavily reliant on the mortgage market. We expect the bank to eventually expand its recent quantitative easing measures in order to drive down long-term rates and drive up inflation expectations. This should drive a reversal in the recent sharp selloff in Australian TIBs.”
“The weakness in the Australian dollar has provided foreign investors with perhaps an even more lucrative opportunity in Australian inflation-linked bonds. As the chart below shows, a huge divergence has opened up over the past month between the AUDUSD exchange rate and the spread of Australian over U.S. 10-year real bond yields.”