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Yield Curves Flatten in Asia as Dollar Liquidity Tightens

(Bloomberg) -- Bonds in Indonesia, India and Australia are witnessing a flattening of yield curves that’s showcasing the challenges these formerly-favored markets face as dollar liquidity tightens.

While Indonesia rushed to raise interest rates to stem a rout in the rupiah, continued weakness in the currency amid an emerging-market rout deepened by the U.S.-China trade war is fanning bets for further tightening. Aberdeen Standard Investments expects the nation’s yield curve to remain flat in the near term.

However, India -- which last month increased benchmark rates for the first time since 2014 -- will probably see its curve steepening later in the year. The same is expected for Australia, with rising yields on U.S. Treasuries seen driving the nation’s long-end borrowing costs higher.

Here’s a look at each market in detail:

The spread between Indonesia’s two- and 10-year government yields shrank this week to as low as nine basis points, the narrowest in two years. The central bank raised the benchmark policy rate by 1 percentage point in less than two months as the rupiah slid to its weakest since October 2015.

“It will most likely stay relatively flat for the time being,’’ Kenneth Akintewe, head of Asian sovereign debt at Aberdeen Standard in Singapore, said of Indonesia’s yield curve. “If there is persistent pressure on the currency, then they will most likely be forced into doing at least one or two more hikes.”

The yield spread was at 28 basis points on Friday, as the rupiah strengthened for the first time in four days.

Once sentiment toward emerging markets improves and the rupiah starts to appreciate, investors would come back to the short end of the curve, especially as valuations are “very attractive,” said Akintewe. “The next move we’d expect to see is a steepening of the curve, but probably not anytime soon.’’

India’s 10-year bonds now offer a spread of 26 basis points over two-year notes, down from 81 in December. Short-term yields have risen more in anticipation of policy tightening after surging oil prices contributed to faster consumer inflation. The Reserve Bank of India increased the benchmark rate in early June and set the stage for a gradual tightening cycle.

A government decision to borrow less from the debt market in the first half of the April-March fiscal year than it has done in previous periods helped slow an advance in benchmark 10-year yields. Further, a resumption of issuance in the one- to four-year maturity zone exerted upward pressure on the front end of the curve.

“This year, bond supply is back-loaded,” said Vivek Rajpal, a rates strategist at Nomura Holdings Inc. in Singapore. This suggests larger issuance in the second half is expected to help steepen the curve, he said, adding that “as we move toward the second half, fiscal concerns may start weighing on the markets.”

A funding squeeze in Australia since the start of this year has led to a surge in short-term borrowing costs for local banks, which in turn has had a spillover effect on the front end of the curve. The spread between the three- and 10-year bond yield has narrowed to 57 basis points from as high as 79 in February.

Australia’s 3-month bank-bill swap rate jumped by the most in eight years during the first half of 2018. Structural factors -- such as falling deposit growth at domestic banks in times of steady credit demand -- mean that elevated money-market rates are here to stay, according to TD Securities.

“The developments in short-term funding rates are directly affecting the outlook for the yield curve in Australia” by “pushing short-term yields higher and thus creating pressure for the curve to flatten,” said Tamar Hamlyn, a Sydney-based principal at Ardea Investment Management, which oversees A$10 billion ($7.4 billion).

However, “as the U.S. recovery continues and yields there continue to rise, all else equal this will have a steepening influence on the Aussie yield curve,” he said. That echoes a view held by Grant Samuel Funds Management.

©2018 Bloomberg L.P.

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