‘Is That a Typo?’ Australia Recoils at Record-Low Yields
The slide means every Australian bond is yielding less than the bottom of the central bank’s 2-3% inflation target.
(Bloomberg) -- Australia is about to reach its last percentage point of interest-rate ammunition, dragging the country’s economy and markets deeper into the low-yield world that’s already engulfed many of its developed-world peers.
Yields on the nation’s 10-year government bonds hit an all-time low 1.26% last week, more than a percentage point below where they started the year. The slide means every Australian bond -- out to the longest maturity of 2047 -- is yielding less than the bottom of the central bank’s 2-3% inflation target.
For a country that avoided the worst of the turmoil that followed the global financial crisis and the unprecedented quantitative easing by central banks from the U.S., Japan and Europe, Australia is now having to contend with a possible future inside that club. The speed of the market’s change has raised eyebrows.
“On the screen a minute ago, Aussie 10-year bond yields at 1.33? I mean, is that a typo?” Richard Yetsenga, chief economist at Australia & New Zealand Banking Group Ltd. in Sydney, quipped in a recent Bloomberg TV interview. “Even six months ago they were like 100 points higher.”
Markets are now pricing about an even chance the Reserve Bank of Australia will cut its policy rate to 0.5% in the next 12 months, a level Governor Philip Lowe has suggested might be close to the lower bound. On Tuesday, Lowe will cut the cash rate by a quarter of a percentage point, to 1%, according to 18 of 26 economists surveyed by Bloomberg.
That Sinking Feeling
“There is a sense of inevitability about where we are heading,” said Sally Auld, a senior interest-rate strategist at JPMorgan Chase & Co. in Sydney. “We’ve seen this play out in a number of other big developed economies over the last decade. Rates have come all the way down to something close to zero, and they stay there for a very long time.”
That’s bad news for financial institutions and anyone relying on fixed-income savings. Goldman Sachs Group Inc. strategists calculate that an official cash rate at 0.5% means bank earnings could slide 15%. That would hurt the biggest component of the country’s equity market -- financial firms comprise almost a third of the main index.
The impact is already being felt for businesses like Challenger Ltd. Shares at the annuities provider are down about 30% this year, with the latest leg down coming as the company cited “lower for longer interest rates” starving its ability to grow profitability.
Ten-year Australian bond yields closed at 1.356% Monday in Sydney.
Downplaying QE
Lowe has signaled openness to further rate cuts, with Australia’s job market short of full employment, as the central bank seeks to put inflation on course with its medium-term target. As for quantitative easing -- a move that could give fresh impetus to the A$542 billion ($380 billion) government-bond market -- the governor says it’s “really quite unlikely” the bank would need to go down that route.
Even so, the 1% level for policy rates proved a harbinger for unorthodox steps in other parts of the world. That’s where the Federal Reserve and the Bank of England shifted toward quantitative measures. Lowe has cited the lower bounds reached by those banks, as well as Canada -- at about 0.25% to 0.5% -- when asked where Australia’s lower level stood.
One plus for conventional policy Down Under is that most home loans are at floating rates linked to the cash rate. That means the RBA’s cuts can flow quickly through to households and, in turn, the economy -- providing lenders pass along the reductions. And the slide in bond yields mean risk assets should do “pretty well,” Yetsenga said.
If it did deploy QE, Australia could have some advantages. A particular strength could be coordination of monetary and fiscal authorities -- something that Europe in particular struggled with earlier this decade.
In extreme policy conditions, the private sector typically has low demand to borrow. And with Australia’s households among the most indebted in the developed world, it’s unlikely they’d be up for boosting leverage.
“The potent policy then becomes monetary policy supporting fiscal policy” said Paul Sheard, a senior fellow at Harvard University’s Kennedy School who had a front row seat during Japan’s multi-decade struggles to battle stagnation and deflation, as an economist in Tokyo. “It’s a more pragmatic kind of approach in Australia’’ when it comes to cooperation among policy makers, he said.
--With assistance from Tomoko Sato, Yvonne Man and Paul Allen.
To contact the reporters on this story: Michael Heath in Sydney at mheath1@bloomberg.net;Adam Haigh in Sydney at ahaigh1@bloomberg.net
To contact the editors responsible for this story: Malcolm Scott at mscott23@bloomberg.net;Christopher Anstey at canstey@bloomberg.net
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