Bloomberg News

Longest Yield Drop Since 1991 on Global Slump: Australia Credit

August 30, 2011

Aug. 31 (Bloomberg) -- Yields on Australia’s benchmark bonds are poised for the longest stretch of monthly declines in 20 years as slowdowns in the U.S. and Europe spur investors to seek the relative safety of sovereign debt.

Slumping global growth and the developed world’s highest borrowing costs lured funds to Australia’s bonds, where the 10- year government yield is falling for an eighth month. The rate is down 42 basis points since July 29 to 4.38 percent at 12:37 p.m. in Sydney. Australian debt delivered 9.24 percent returns this year, second to New Zealand’s 9.34 percent among 21 developed nations tracked by Bloomberg.

Australian two-year yields are set for the biggest monthly drop since 2008 as fragile domestic confidence, Europe’s debt crisis and a ratings downgrade for the U.S. prompted bets the Reserve Bank will cut its 4.75 percent benchmark interest rate for the first time in more than two years. Retail sales slumped and the jobless rate climbed after investors drove up the Australian dollar to a record in July, curbing profits for companies from department stores to surf-wear makers.

“In an environment where investors are seeking yield, good liquidity and relative safe havens, the Australian government bond market is one of the best places to put your money,” said Tony Morriss, head of interest-rates research in Sydney at Australia & New Zealand Banking Group Ltd. “Australia rates quite highly for a developed market given we still have a lot of policy flexibility in terms of the ability to cut rates.”

Australia and Singapore are each poised for an eighth straight month of declining yields for government securities maturing in 10 years, the only such fixed-income markets among 50 tracked by Bloomberg.

‘Dangerous New Phase’

U.S. Treasuries returned 7.5 percent this year, according to indexes compiled by the European Federation of Financial Analyst Societies and Bloomberg. The 10-year benchmark yield dropped to a record low 1.97 percent on Aug. 18 and was at 2.16 percent today, or 223 basis points less than similar-maturity Australian rates.

Christine Lagarde, who took over in July as managing director of the International Monetary Fund, warned this month that the world economy is in a “dangerous new phase.”

The U.S. should arrest a slide in house prices and European banks must boost capital to prevent the continent’s debt crisis from spreading, Lagarde said to international finance officials and economists in Jackson Hole, Wyoming.

U.S. gross domestic product climbed in the first half of this year at the slowest pace since the recovery began in mid-2009. Euro-area growth slowed to 0.2 percent in the second quarter from 0.8 percent in the first -- with the German economy almost grinding to a halt -- as Europe’s debt crisis roiled financial markets and weighed on confidence.

Retail Slump

Signs have emerged that Australia’s growth prospects are also softening. Retail sales unexpectedly declined for a second month in June as consumer confidence slumped to the lowest in two years and the unemployment rate rose for the first time since October, private and government numbers showed this month.

Billabong International Ltd.’s shares dropped 42 percent in August as the Burleigh Heads, Australia-based maker of surf wear scrapped its forecast for earnings-per-share growth of more than 10 percent after gains in the Australian dollar slashed the value of overseas sales.

BlueScope Steel Ltd., Qantas Airways Ltd. and Westpac Banking Corp. all announced plans this month to trim their workforces as Australian consumers cut spending and a currency that’s risen about 20 percent from a year ago hurts demand for exports.

Prime Minister Julia Gillard yesterday warned the nation’s factory workers face increasing hardship.

‘Tough Days’

“We are seeing a mining industry going ahead by leaps and bounds but we are also seeing pressures on manufacturing, pressure on industries like tourism,” Gillard told reporters in Port Kembla, south of Sydney. “These are tough days for a number of working people who are contemplating their futures.”

The Australian dollar traded at $1.0677 as of 12:44 p.m. in Sydney and reached $1.1081 on July 27, the strongest since it was freely floated in 1983.

Cash-rate futures show investors are betting RBA Governor Glenn Stevens will slash the benchmark rate to 3.96 percent by December from 4.75 percent currently. All government bond maturities are yielding less than the cash rate, after falling to that relative level this month for the first time since 2009.

Seventeen of 23 economists surveyed by Bloomberg News predict the RBA will keep its benchmark unchanged this year, four forecast at least one cut while two anticipate an increase.

RBA Ammunition

Stevens signaled Aug. 26 that the central bank has sufficient “ammunition” with rates to respond to a sudden downturn in the global economy, an outcome he said he isn’t anticipating.

The RBA raised its key borrowing cost by 175 basis points between October 2009 and November last year to cool inflation amid the country’s biggest resources boom since the 19th century gold rush. Investors in inflation-liked debt are estimating annual Australian consumer-price gains will average 2.56 percent in the coming five years, compared with the RBA’s target to hold underlying inflation between 2 and 3 percent.

Australian companies and consumers are better positioned to withstand market volatility than they were three years ago, Stevens said last week.

Price swings on Australian 10-year bond futures averaged 16.22 basis points this month, the most since November 2008 and one of just seven occasions when the figure exceeded 16 basis points. As of yesterday, the three-year contract had averaged a 23.87 basis-point gap between intraday highs and lows, the most since October 2008 when the spread averaged 24.52. Those are the only two occasions when the figure exceeded 18 basis points since Bloomberg started tracking the data in 1990.

Spreads Widen

Australian corporate bonds returned 0.9 percent this month as of yesterday in their ninth straight month of gains, while global company notes dropped 0.3 percent and U.S. corporate securities gained 0.1 percent, Bank of America Merrill Lynch indexes show.

Still, the extra yield investors demand to hold Australian notes instead of government debt surged 42 basis points to 223, the widest gap since Dec. 18, 2009, the Merrill Lynch data show. That’s frozen the market for new bond sales by non-financial companies in Australia, with the A$150 million ($160 million) sale of notes on July 8 by a local unit of Volkswagen AG the last such offering, data compiled by Bloomberg show.

‘Ugly Month’

“It’s been an ugly month, with credit spreads widening and riskier debt such as bank subordinated paper being hit particularly hard,” said Mark Mitchell, head of credit at Sydney-based Kapstream Capital, which manages A$3.9 billion. “This could be a good buying opportunity for some of these assets if you’re able to wear a bit of mark-to-market risk.”

The average cost of credit-default swaps on subordinated debt of the nation’s four largest banks jumped as high as 280.2 basis points on Aug. 29, the highest since March 2009, from 192.2 on July 29, CMA data show.

A broader gauge of Australian corporate bond risk was set for its biggest monthly increase in more than two years.

The Markit iTraxx Australia index of default-swap contracts on 25 of the nation’s biggest companies rose 46.6 basis points in August to 165.4 yesterday, the fourth month of increases, CMA data show. It’s on course to rise the most since February 2009, according to CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market.

--With assistance from Daniel Petrie in Sydney. Editors: Garfield Reynolds, Edward Johnson

To contact the reporters on this story: Candice Zachariahs in Sydney at czachariahs2@bloomberg.net; Sarah McDonald in Sydney at smcdonald23@bloomberg.net

To contact the editors responsible for this story: Rocky Swift at rswift5@bloomberg.net; Shelley Smith at ssmith118@bloomberg.net


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