Bloomberg News

Highest Yields for AAA Spur Foreign Demand: Australia Credit

June 18, 2012

Australian government bonds are returning twice as much as AAA rated peers this quarter as the global economy falters and the central bank cuts interest rates.

Investors in the country’s bonds earned 6.2 percent since March 31, the most after Portugal among developed markets, data compiled by Bloomberg show. The nine other top-rated sovereign markets rose an average 2.6 percent. The benchmark Australian 10-year rate of 3.05 percent is at least 1.1 percentage points more than similar-dated AAA government securities.

Yields on all Australian government debt are below the Reserve Bank’s 3.5 percent cash-rate target as swaps show policy makers may reduce borrowing costs even after mining investment rose last quarter to a record. The RBA releases minutes today from the June 5 meeting when it cut the benchmark for a second- straight month. Foreign buyers raised holdings to an all-time high 79 percent of Australia’s A$246 billion ($248 billion) of bonds in the first three months of 2012.

“What’s driving the rally is the allocation by foreign reserve funds and others seeking a safe haven with yield,” said Anthony Kirkham, head of investments at Western Asset Management Co. in Melbourne, where he helps oversee A$15 billion. “The question of whether it’s going to continue is dependent on what’s going on in Europe.”

Mining Boom

Australia is experiencing a once-in-a-century mining boom that’s helping the economy tap into growth in emerging markets as a fiscal crisis threatens Europe and the U.S. struggles to recover from the turmoil brought on by the collapse of its housing market.

Demand for Australia’s coal, iron ore and natural gas is being driven by industrial growth and urbanization in emerging Asia, particularly China. The world’s fastest growing major economy is the No. 1 destination for Australian exports and its appetite for resources is spurring investment in mineral projects even as Chinese policy makers seek to engineer a gradual slowdown.

Mineral exploration spending in the South Pacific nation climbed to a record A$1.086 billion in the March quarter and the investment pipeline has reached an estimated A$500 billion, according to Treasurer Wayne Swan’s weekly economic note.

Australian growth accelerated in the first quarter, with gross domestic product increasing by 1.3 percent from the previous three-month period. That was more than twice the pace predicted by economists.

Economic Resilience

The resilience of Australia’s economy, along with the lowest debt burden among states with a stable AAA rating means the country’s sovereign debt is increasingly viewed as a haven. The proportion of Australian debt maturing in at least a year owned by foreigners climbed to 79 percent as of March 31 from 76 percent three months earlier, according to government data based on market values from the country’s statistics bureau and the Australian Office of Financial Management.

The pledge by Prime Minister Julia Gillard to return the government budget to surplus in the coming fiscal year may also reduce the supply of debt, putting downward pressure on rates.

The results of Greece’s elections prompted bonds to slide yesterday as equities rallied. Earlier this month, yields on all Australian bond maturities fell to records this month and remain below the cash rate target.

Relief Rally

“The crisis is anything but over,” said Russell Jones, the Sydney-based global head of fixed-income strategy at Westpac Banking Corp., Australia’s second largest lender. “As soon as this particular relief rally burns itself out, which I doubt will be a very long way away, I think you’ll see money coming back into Australia.”

The benchmark 10-year yield climbed nine basis points to 3.08 percent yesterday in Sydney. The extra premium over similar-dated U.S. Treasuries widened five basis points to 146 basis points from the end of last week.

Elsewhere in Australia’s credit markets, the Markit iTraxx Australia index of credit-default swaps that measures perceptions of corporate bond risk fell 9 1/2 basis points to 179.75 basis points as of 5:02 p.m. yesterday in Sydney, according to Markit Group Ltd.

Credit-default swaps on the debt of Fairfax Media Ltd. (FXJ), Australia’s second-largest newspaper publisher, yesterday fell 10 basis points to 375 as of 12:46 p.m. in Sydney, according to Westpac prices. The company announced plans to cut 22 percent of its workforce, close printing sites and restructure its operations in a bid to combat falling revenue.

Fairfax CDS

The extra yield investors demand to hold corporate bonds rather than government debt fell three basis points to 275 basis points on June 15, Bank of America Merrill Lynch indexes show.

The Australian dollar, the world’s fifth-most traded currency, rose to $1.0117 as of 5:02 p.m. in Sydney yesterday and touched $1.0135, the strongest since May 10.

Traders are betting that RBA Governor Glenn Stevens will lower borrowing costs further, with overnight index swaps data compiled by Bloomberg indicating there is another percentage point of easing by the end of 2012. The central bank is scheduled to publish minutes of its June deliberations today and will meet again on July 3.

“The RBA’s got a lot more ammunition than most, so I think it’ll be firing some of it,” said Westpac’s Jones. “If they don’t go in July, I think it’s not too far away.”

Inflation Subdued

With government data indicating inflation is in check, the central bank has scope to act. Consumer prices increased by 1.6 percent in the first quarter over the previous 12 month period, while the trimmed mean measure rose by 2.2 percent. The RBA targets a range of 2 percent to 3 percent for underlying inflation.

The gap between yields on Australia’s 10-year inflation- linked bonds and benchmark notes, known as the breakeven rate, was at 2.47 percent, below this year’s high of 2.92 percent on March 19.

Indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies show Australian government bonds are heading for the biggest three-month climb since 2008, when global financial markets were thrown into chaos following the bankruptcy of Lehman Brothers Holdings Inc. Australia is one of 12 AAA rated nations worldwide, of which Luxembourg and Singapore aren’t covered by the Bloomberg/EFFAS indexes.

Bond Buying

The crisis that followed Lehman’s collapse led policy makers around the world to drop interest rates to records, and major central banks in the U.S., Japan, Europe and the U.K. have held down their benchmarks and bought bonds to lower borrowing costs across their economies.

Even after 1.25 percentage points of cuts since November, Australia’s policy rate remains the highest among major developed economies, further cementing the appeal of its bonds.

“We still have a relatively high-yield structure compared to most of the advanced world,” said Adam Donaldson, head of debt research at Commonwealth Bank of Australia, the nation’s largest lender. “The combination of that with a AAA rating, a very sound ratings outlook, and limited bond supply is very attractive for offshore investors trying to diversify their risks at the moment.”

He forecasts the 10-year yield will fall to a record 2.5 percent by December.

To contact the reporters on this story: Benjamin Purvis in Sydney at bpurvis@bloomberg.net; Kristine Aquino in Singapore at kaquino1@bloomberg.net

To contact the editor responsible for this story: Rocky Swift at rswift5@bloomberg.net


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