Templeton Sees More RBA Cuts Capping Aussie Bond Yield Jump

(Bloomberg) -- Franklin Templeton is betting the Reserve Bank of Australia will cut its cash rate two more times, reining in bond yields that have surged more than any other top-rated sovereign market over the past two months.

The selloff in bonds presents a buying opportunity and Templeton added positions over the past few weeks that benefit if Aussie interest rates decline, said Chris Siniakov, who leads the money manager’s fixed-income team in Melbourne. He said the RBA is likely to reduce its key rate to 1 percent by mid-2017 from an already record low 1.5 percent. The swaps market was pricing the probability of that at just 4 percent on Tuesday in Sydney.

Stabilizing inflation, improved growth prospects and concern that easy policy will stoke housing market risks have helped to stay the RBA’s hand. A rally in commodity prices has also boosted the outlook for the country and Australia’s 10-year bond yield has climbed by about half a percentage point since the end of August. That’s double the increase in comparable U.S. yields, which have been climbing on signals the Federal Reserve is likely to increase its benchmark next month.

“For Australia, the selloff’s been sharper partly because the market has removed expectations for any further Reserve Bank easing,” Siniakov said in a telephone interview last week. “The RBA has some more work to do here and that will tend to anchor the level and the extent that yields can sell off.”

Templeton, which had $733 billion of assets under management globally at the end of September, has been “incrementally adding” to its bet on Aussie bonds as the selloff has persisted, Siniakov said. The duration of his portfolio -- a measure of how sensitive it is to interest-rate moves -- can range between positive 2 1/2 and negative 2 1/2, and it’s now climbed to more than positive 2, according to Siniakov.

Buying Opportunity

“We are currently skewed on the long side, expecting the recent pickup in the yields will be retraced,” he said. “With very little priced in for the RBA, if you have the fundamental view of the economy running along at below trend and segments of the economy in particular needing further assistance, then I think it is a buying opportunity at these levels.”

Australia’s 10-year yield was at 2.35 percent as of 10 a.m. on Tuesday in Sydney, compared with 1.83 percent for comparable U.S. paper and minus 0.055 percent for similar Japanese notes. The three-year Aussie yield was at 1.70 percent, 30 basis points above its level at the end of August, and the odds of even one quarter-point reduction from the RBA by the end of June were just 31 percent, according to swaps data.

Templeton expects inflation in Australia will “persist at a lower level” and that the RBA is going to face economic growth pressures as domestic demand struggles to pick up, Siniakov said. “It’s been low and if that persists for a longer period of time and maybe even heads lower, then the RBA will be forced into action,” he said.

Siniakov has so far favored implementing his strategy at the shorter end of the yield curve, where moves are more closely tied to domestic monetary policy, although he may change that if longer maturities become more attractive.

“If the long end continues to steepen up, we may shift the duration further up the curve,” he said. “So, keep about the same magnitude, but move further out the curve where there is a higher beta, larger potential gains from the market retracing.”