Japan Investors Shy Away From Aussie as Yield Spread Shrinks

(Bloomberg) -- Japanese investors are falling out of love with Australia’s currency and bonds as the South Pacific nation’s economic growth slows and its yield premium vanishes.

Funds in Japan bought a monthly average of 38 billion yen ($337 million) of Australia’s debt this year, down from 49 billion yen in 2016 and 53 billion yen in 2015, data from the Ministry of Finance show. The value of Australian dollar-denominated mutual funds sold to retail investors slid to a one-year low of 2.81 trillion yen in October, from as much as 5.45 trillion yen in February 2012, according to the Investment Trust Funds Association of Japan.

The Aussie has weakened against all except one of its Group-of-10 counterparts in the past month as slowing growth pushes back expectations for when the Reserve Bank of Australia will raise interest rates. The currency has also been weighed down by a slowdown in China, Australia’s biggest trading partner, and concern about the health of Chinese banks.

“Investors won’t be enthusiastic as Australia’s economy is not strong enough for the Reserve Bank of Australia to raise interest rates repeatedly,” said Eiichiro Miura, general manager of the fixed-income department in Tokyo at Nissay Asset Management, which oversees the equivalent of $94 billion. “Uncertainty about the banking system surrounding China is another area of concern when you think about Australia.”

Vanishing Premium

The Reserve Bank of Australia is forecast to leave its cash rate target at a record-low 1.50 percent on Tuesday, just 25 basis points above the Federal Reserve’s benchmark. U.S. policy makers will raise their key rate three times by the end of next year to 2 percent, surpassing Australia’s which will only increase to 1.75 percent, according to a Bloomberg survey.

The extra yield on Australia’s 10-year bonds over similar-maturity Treasuries has shrunk to 16 basis points from as high as 278 basis points in November 2010. The premium on two-year yields dropped below zero this month for the first time in almost two decades.

“The fact that in the two-year sector, yields on securities of both countries are around the same indicates that the market is already factoring" in that the 10-year spread will disappear too, Nissay’s Miura said. “Australia had the advantage against other developed countries of being a high-yielding country but that advantage is clearly fading."

Aussie’s Slide

The slide in the Australian dollar is making Japanese investors reluctant about increasing exposure, according to Masashi Murata, a currency strategist at Brown Brothers Harriman in Tokyo.

“You really can’t treat the Aussie as a high-yielding currency any more," he said. “There’s an impression that the Aussie rose quite significantly after the Lehman crisis, but purely looking at the yield levels now with the U.S., there’s no reason to be aggressive about buying the Aussie."

Australia’s dollar dropped to a five-month low of 75.32 U.S. cents on Nov. 21, down from as much as 81.25 cents in September. It was at 76.05 cents at 9:05 a.m. Monday in London.

“As we’ve seen many economic indicators falling below expectations, there are few reasons to take long positions in the Aussie," Murata said. “The Aussie’s rise above the 80-cent level was clearly overdone. The Aussie could fall further and we have a bearish outlook. The next target for the Aussie will be 74 cents, while it could fall to 70 cents by early next year."

To contact the reporters on this story: Chikafumi Hodo in Tokyo at chodo@bloomberg.net, Daisuke Sakai in Tokyo at dsakai2@bloomberg.net.

To contact the editors responsible for this story: Tan Hwee Ann at hatan@bloomberg.net, Nicholas Reynolds

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