Bloomberg News

Rate Signal Sends Yield Gap to 20-Month Low: Australia Credit

October 04, 2011

Oct. 5 (Bloomberg) -- Australian bond yields tumbled to the lowest level in 20 months relative to U.S. Treasuries after central bank Governor Glenn Stevens indicated he’s willing to cut the developed world’s highest benchmark interest rate.

The extra yield investors demand to hold the nation’s two- year securities instead of Treasuries fell to 3.21 percent yesterday, the least since Feb. 3, 2010, from as much as 4.58 percent on Jan. 3. Cash-rate futures showed traders wagering on an 78 percent chance the benchmark will be cut to 4.25 percent from 4.75 percent by November.

Stevens, who held rates yesterday for an 11th straight month, signaled slowing inflation may give him scope to lower borrowing costs. Such a move would follow cuts by nations from Brazil to Israel to counter slowdowns in Europe and the U.S. In Australia, business and consumer confidence have weakened in recent months and the nation’s unemployment climbed to a 10- month high in August.

“You have shorter-maturity bond yields now being driven by an RBA that’s opening up the possibility of a response to slower growth,” said Tony Morriss, head of interest-rates research in Sydney at Australia & New Zealand Banking Group Ltd. “I don’t really see the catalyst for yields to rise too far when you’re looking at the RBA possibly easing as early as next month.”

Australia’s currency fell to the lowest level since September 2010 yesterday against its U.S. counterpart after Stevens said “an improved inflation outlook would increase the scope for monetary policy to provide some support to demand, should that prove necessary.”

Weaker Dollar

The local dollar has dropped 14 percent from its record- high $1.1081 reached July 27 as speculation mounts that Greece will default and spur a repeat of the 2008 credit freeze that followed the collapse of Lehman Brothers Holdings Inc. After the RBA decision yesterday, the currency fell as low as 93.88 U.S. cents and traded at 95.19 at 12:41 p.m. in Sydney today.

The central bank noted the currency’s decline in yesterday’s statement and a broader “easing” in financial conditions in the economy.

“While there remain good reasons to expect solid growth over the medium term, the indications are that the pace of near- term growth is unlikely to be as strong as earlier expected, due both to local and global factors, including the financial turmoil and related effects on business confidence,” Stevens said in the statement.

Accessing Funds

The spread between the interest Australian banks pay when borrowing from each other for three months and swaps tracking expectations for the RBA’s benchmark was little changed at 37 basis points after yesterday falling 14 basis points. The gap, which is a gauge of banks’ difficulty in accessing funds, closed at 61 basis points on Aug. 8, the highest since January 2009.

Australia’s two-year bond yield pared a 13 basis point, or 0.13 percentage point, decline yesterday and rose 2 basis points to 3.49 percent today. The 10-year rate rose 4 basis points to 4.04 percent, or 222 basis points more than similar-maturity Treasuries.

The extra yield investors demand over government securities to hold Australian corporate debt surged 64 basis points last quarter to 241 basis points, as global premiums jumped 101 to 264, Bank of America Merrill Lynch indexes show. The spread on the Australian index held at 241 on Oct. 4, the highest since September 2009.

The Markit iTraxx Australia index fell 1 basis point to 239 as of 11:36 a.m. in Sydney, according to Westpac Banking Corp. The benchmark is headed for its first decline since Sept. 27, CMA prices in New York show.

Rising Unemployment

Monthly employment growth in Australia averaged 2,800 from January through August, less than a 10th of the average of 30,500 in the first eight months of 2010. The nation’s unemployment rate in August rose for a second straight month, reaching 5.3 percent, the highest level since October 2010.

Stevens said the labor market is “a little softer” and consumers are “more concerned about the possibility of unemployment rising.” A weaker job market reduces the likelihood of a “significant acceleration” in labor costs, the RBA governor said.

Consumer prices will rise at a 2.37 percent annual pace over the next five years, yields on inflation-linked debt showed yesterday.

“The path for inflation may now be more consistent with the 2 percent to 3 percent target in 2012 and 2013,” Stevens said yesterday. “The exchange rate has also declined from the very high levels of a few months ago.”

Rate Outlook

Investors predict at least 1.5 percentage points of rate reductions over the next 12 months, according to a Credit Suisse Group AG index based on swaps trading.

“November is definitely a live meeting and the outcome will very much be determined by conditions in the market and how the data pans out,” said Jarrod Kerr, director of Australia rates strategy at Credit Suisse in Singapore.

The Australian Bureau of Statistics is scheduled to release a report on September employment figures on Oct. 13 and third- quarter data on consumer prices Oct. 26. The RBA next meets Nov. 1.

Retail sales advanced more than economists forecast in August for a second straight month as consumers spent more on household goods and dining out, a report today showed.

Mining Industry

While unemployment has risen and confidence fallen in Australia, government reports yesterday underscored the strength of the nation’s mining industry.

Australia’s exports surged in August to a record A$28.4 billion ($27 billion) on coal shipments, and the nation’s A$3.1 billion trade surplus was the second-widest on record.

The RBA, which last raised rates in November, has balanced inflation driven by resources investment and a stronger currency that’s hurt manufacturing jobs and damaged confidence.

“It’s pretty clear at this stage that the RBA is less interested in what happens at home and more interested in what happens abroad,” said Robert Ryan, a currency strategist at BNP Paribas SA in Singapore. “The focus is much more on Europe, financial market volatility and the possible spillover into confidence in Australia.”

Stevens reduced rates from 7.25 percent to a 49-year low of 3 percent from September 2008 to April 2009 as the collapse of Lehman sparked a global financial crisis.

The RBA boosted its rate seven times from October 2009 to November 2010, tempering a rise in consumer debt, which more than tripled in the past 20 years to 153.7 percent of disposable income in the second quarter.

“The RBA does not tend to fine-tune,” said Paul Bloxham, chief economist for HSBC Holdings Plc in Sydney and a former central bank official. “We think the RBA is still very keen not to have to cut rates, if it can avoid it, given the medium-term outlook for the mining investment boom, the very high terms of trade and the limited supply capacity of the economy.”

Treasurer Wayne Swan said after yesterday’s decision that global instability, cautious consumers and the still high dollar are putting “sustained pressure” on parts of Australia’s economy. The RBA confirmed “it has room to move if the global situation further deteriorates,” Swan said in a statement.

--With assistance from Sarah McDonald in Sydney. Editors: Brendan Murray, Edward Johnson

To contact the reporters on this story: Michael Heath in Sydney at mheath1@bloomberg.net; Candice Zachariahs in Sydney at czachariahs2@bloomberg.net

To contact the editors responsible for this story: Stephanie Phang at sphang@bloomberg.net; Rocky Swift at rswift5@bloomberg.net


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