Bloomberg News

Pimco Drawn to Yields Spurs Best Bond Rally: Australia Credit

September 30, 2011

Sept. 30 (Bloomberg) -- Australian sovereign and company bonds are set for the steepest rally since 2008 as the highest yields among developed nations untainted by Europe’s debt crisis attract Pacific Investment Management Co.

Australian debt gained 4.8 percent this quarter as of Sept. 28, the most since the last three months of 2008, and beat all markets tracked by Bank of America Merrill Lynch in the past 12 months. While Australian government yields fell 98 basis points to average 4.05 percent, Bloomberg data show the only developed markets with higher rates are at the center of Europe’s struggles: Greece, Ireland, Italy, Portugal and Spain.

The developed world’s highest benchmark borrowing rate and second-lowest fiscal burden are luring investors to Australia as Greece faces default and European leaders seek to protect their banks from contagion. Foreign buyers added A$15.9 billion ($15.5 billion) of government debt in the first half of 2011 to hold 74.7 percent of Australia’s bonds as of June 30, the most in 2 1/2 years, according to the central bank.

“There is an attraction in the Australian bond market for offshore investors both from a credit perspective as a strong sovereign and from a real yield perspective,” said Julian Foxall, a Sydney-based portfolio manager at the Australian unit of Pimco, which manages the world’s biggest bond fund. “The Australian government bond market stands out in terms of value relative to other markets quite well. In an uncertain world that’s a reasonable place to be.”

World Beaters

Australian sovereign bonds returned 9.8 percent the past 12 months, the most among 26 markets tracked by Bloomberg/EFFAS indexes. Corporate notes gained 9.6 percent, the biggest advance worldwide, Merrill Lynch data show.

The yield on Australia’s 10-year government notes plunged 99 basis points to 4.22 percent this quarter, the biggest drop since 2008 and the first time since 2002 that yields have fallen for three straight quarters. The rates declined nine straight months, the longest stretch since at least 1978.

The premium the debt offers over similar-maturity U.S. Treasuries was at 225 basis points unchanged from Dec. 31, while the spread over German bunds has narrowed to 226 from 258.

Bonds are rallying as global financial turmoil spurs declines in equity markets worldwide.

Haven From Turmoil

“Fixed income has proved a safer haven this year,” said Chris Viol, a Sydney-based credit analyst at UBS AG. “With volatility and uncertainty becoming the norm, investing part of your portfolio in defensive fixed income makes sense.”

The S&P/ASX 200 Accumulation Index has lost 12 percent this year.

Australia’s bond market had its most volatile weeks on record in August as international concern grew that default by Greece would harm the euro region’s core countries and tip the global economy back into a recession.

The so-called Aussie dollar, the world’s fifth-most traded currency, has dropped for the first quarter since the three months ended June 30, 2010, trading at 97.24 U.S. cents as of 5:15 p.m. in Sydney today, from $1.0722 at the start of the current period. The currency reached $1.1081 on July 27, the strongest since it was freely floated in 1983.

Almost two years into the debt crisis centered on Greece, the U.S. is prodding European governments to show more urgency. They are “trying to take responsible actions, but those actions haven’t been quite as quick as they need to be,” President Barack Obama said on Sept. 26.

The entire Australian bond curve, with maturities out to 2023, has been yielding less than the 4.75 percent policy rate since Aug. 9 as futures traders bet the Reserve Bank will be forced to lower borrowing costs.

‘Very Expensive’

Government notes are vulnerable to a decline if Europe’s leaders can bolster confidence they can contain financial turmoil, said Stephen Miller, a managing director in Sydney at BlackRock Inc., which oversees about $3.7 trillion worldwide.

Australian sovereign debt looks “very, very, very expensive,” he said. Miller holds close to the same amount of government debt in his portfolios as required by benchmarks his funds track, and is “slightly overweight” Australian corporate bonds.

“The Aussie credit market, to some extent, is better protected in an environment where risk sentiment deteriorates because it does tend to be a short-maturity, high credit quality market,” he said.

All the Australian corporate debt maturing in the next two years rated by Moody’s Investors Service is investment-grade, which reduces refinancing risk, the risk assessor wrote in a Sept. 19 report. In contrast, 55 percent of the U.S. debt market and 40 percent of Canada’s is made up of junk-rated securities, Moody’s said.

“Australian corporate issuers are well positioned to ride out further global uncertainty,” Moody’s wrote.

Expanding Economy

Australia’s economy will expand 1.84 percent in 2011 before accelerating 4.25 percent in 2012, the fastest pace since 2007, according to strategists’ estimates compiled by Bloomberg. Gross domestic product in China, Australia’s biggest trading partner, will surge 9.3 percent this year, a separate survey shows.

Bonds sold by utility companies APA Group and SP AusNet returned at least 1.9 percent in September, the most in Merrill Lynch’s Australian Corporate & Collateralized Index. Australian dollar-denominated bonds sold by Royal Bank of Scotland Group Plc and AXA SA lost 1.7 percent and 1.3 percent, the data show.

Bond Risk

The Markit iTraxx Australia index of credit-default swaps surged 102 basis points since June 30 to 215 as of yesterday, outpacing an 84 basis-point climb to 189 for the Markit iTraxx Europe, CMA prices show. The Markit CDX North America Investment Grade Index climbed 48 basis points to 139.

Swaps on the Australian sovereign jumped 41 basis points to 98, while U.S. contracts rose to 53 from 51, according to CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market.

AMP Capital Investors, a Sydney-based firm with about A$30 billion of fixed-income assets under management, is “reasonably cautious” on Australian corporate debt, including that of the nation’s banks, because the problems in Europe affect access to wholesale funding markets, according to Jeff Brunton, the company’s head of credit markets.

“We certainly think that the fundamentals in Australia are stronger than Europe and the U.S.,” Brunton said. Still, “during these crises, that all becomes secondary.”

--Editors: Garfield Reynolds, Brendan Murray

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

To contact the editor responsible for this story: Shelley Smith at ssmith118@bloomberg.net


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