Yield spread narrowing rapidly

The yield advantage on Australian sovereign bonds may crash to the least since 2001 as the Reserve Bank bank shows it’s willing to cut record-low interest rates even further, CBA says.
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The extra yield benchmark Australian notes offer over US counterparts will shrink to 80 basis points by 2015 and may drop to as little as 50, Commonwealth Bank forecasts.

Economists expect the to narrow to 87 basis points by September 2014, according to a Bloomberg survey, after touching 107 yesterday, the least since November 2008.

The Reserve Bank said this week it retains scope to cut rates as the economy is dragged down by the end of a record mining investment boom and manufacturing struggles to fill the gap. Lower borrowing costs would further reduce sovereign yields and weaken the Aussie dollar just as the US Federal Reserve signals it may reduce monetary stimulus this year.

“We are going to have a slowdown in Australia, and if things go badly, it could turn into a recession,” said Philip Brown, a fixed-income strategist at CBA. If the run of poor data continues in Australia against the backdrop of a resurgent US, a spread of 50 basis points is plausible, according to CBA.

The 10-year rate was 3.63 per cent this afternoon, compared with 2.35 per cent for similar-dated US Treasuries. Australian sovereign debt returned 1.2 per cent from the end of March to June 18, while US bonds handed investors a 1 per cent loss, Bank of America Merrill Lynch indexes show.

The gap to Treasuries reached 51 basis points on March 28, 2006, the least since May 2001, before soaring to a decade-high of 277 in February 2008.

“The inflation outlook as currently assessed might provide some scope for further easing, should that be required to support demand,” the RBA said this week in minutes from its June 4 meeting, when it left its benchmark at 2.75 per cent.

The central bank repeated that resource investment was near its peak and would remain high for the next year or so. There was “considerable uncertainty” beyond that, it said.

Manufacturing has failed to signal it can pick up the slack. It contracted for a 15th month in May, after dropping to a four-year low the month before, according to purchasing managers surveys by Australian Industry Group.

“It’s the transition phase in the Australian economy that’s concerning the market,” said Steven Mansell, the Sydney-based head of Group of 10 rates strategy for the Asia-Pacific region at Citigroup. “The market will hold on to expectations of lower policy rates, whereas the only way is up in the US.”

Swaps markets are pricing in 28 basis points, or 0.28 percentage point, of RBA cuts over the coming year, while they see the equivalent of 16 basis points of tightening at the Fed, according to Credit Suisse indexes.

US economic growth has trailed Australia’s since 2006. It will recover to match the South Pacific nation by 2015, with both nations’ output increasing 3 per cent that year, according to the median forecast of economists polled by Bloomberg. Strategists raised their forecasts for the possibility of an Australian recession in the next 12 months to 10 per cent this month, from 5 per cent in May.

“With all the liquidity awash in the world, and an uncertain world with no growth, what you do is search for yield, and Australia’s triple-A bond market was one of the primary beneficiaries,” said Sam Tuck, a senior foreign-exchange manager at ANZ. “Now that can start to unwind.”

Bloomberg

The original release of this article first appeared on the website of Shanghai Night Net.