Record bond rally colliding with RBA

Sydney: A record rally in Australia’s government bonds as commodity prices slump looks set to collide with data this week showing the fastest economic growth in five years, allowing the central bank to hold interest rates.

While economists and swaps traders predict Reserve Bank of Australia Governor Glenn Stevens will leave the overnight cash rate target at 3.5 per cent on Tuesday for a third month, they also estimate he will need to lower rates later in the year, data compiled by Bloomberg show. The economy probably expanded 0.8 per cent last quarter from the prior three months for the strongest half of growth since 2007, a Bloomberg News survey of economists showed before a September 5 government report.

BHP Billiton’s decision to delay an estimated $33 billion (Dh121.2 billion) expansion of the Olympic Dam mine in South Australia is fueling concern a slump in Chinese demand will end the biggest mining bonanza since the 19th century gold rush. Ten-year government notes are climbing for a record 12th day, bringing down yields by 44 basis points to 3.04 per cent as of 12.42pm in Sydney. The premium over similar-dated US Treasuries shrank to 149 basis points today, the least since July 27.

“We’ve had major falls in key commodity prices and that does raise a question mark about the strength and longevity of the mining investment boom,” said Brian Redican, a senior economist in Sydney at Macquarie Group, the nation’s largest investment bank. “The headwinds facing the economy are getting stronger and that will ensure that the Reserve Bank needs to take further stimulatory measures.” He predicts the central bank will lower the rate to three per cent by year-end.

RBA Outlook

Interest-rate swaps show an 80 per cent chance that Stevens will keep the benchmark unchanged on Tuesday, according to data compiled by Bloomberg. He lowered borrowing costs by 125 basis points from November through June to bolster the economy against Europe’s debt crisis and China’s slowdown. All 24 economists surveyed by Bloomberg News forecast no change.

China’s manufacturing unexpectedly contracted for the first time in nine months in August as orders shrank, a government survey showed September 1. The final figure released today for a similar gauge by HSBC Holdings Plc and Markit Economics also showed a slowdown in factory output last month.

The readings add to evidence of weakness after a surfeit of unsold goods left near-record rubber stocks at China’s main shipment port and deepening financial strains saw overdue loans jump 27 per cent at the five biggest banks in the first half.

Aussie economy

Australia’s gross domestic product expanded at an annual pace of 3.7 per cent last quarter, the median estimate in a separate Bloomberg News survey showed. The economy expanded by 1.3 per cent in the three months ended March 31 and grew at a 4.3 per cent annual rate, the fastest in the developed world.

The local currency has climbed 71 per cent from a trough of 60.09 US cents it reached in October 2008 during the global credit crunch, the biggest gain among 16 major currencies tracked by Bloomberg. Stevens told lawmakers last month he was “a little surprised” at the Aussie’s strength.

The local dollar’s climb has propelled it to the widest divergence in more than a decade from Australia’s terms of trade, and also left it out of step with a drop in government bond yields. The world’s fifth-most traded currency fell 0.6 per cent to $1.0258 as of 12.43pm in Sydney, extending last month’s 1.7 per cent slide. It is still 37 per cent higher than its average since exchange controls were scrapped in 1983.

“The RBA is in a difficult position because the outlook in our part of the world is deteriorating given how much China is coming off the boil, yet the currency is not really responding,” said Jonathan Cavenagh, a strategist in Singapore at Westpac Banking Corp. “The RBA has more heavy lifting to do from an interest-rate perspective.”

Export windfall

Australian retail sales dropped 0.8 per cent in July from a month earlier, when they rose a revised 1.2 per cent, the Bureau of Statistics said on Monday. That was the steepest monthly fall since October 2010 and compares with a median forecast for a 0.2 per cent gain in a Bloomberg News survey.

Traders are pricing in an 81 per cent chance that the RBA will lower borrowing costs by at least another 50 basis points by year-end to three per cent, matching the 50-year low the benchmark reached at the height of the global financial crisis that started in 2008.

The windfall Australia gets from exports, called the terms of trade, will slump 15 per cent in the final three months of 2012 from a year before, according to Adam Boyton, chief economist in Sydney at Deutsche Bank AG. A drop of that size presaged a recession three of the five times it’s happened in the past half century, Boyton said last month. The central bank estimates the terms of trade reached a 140-year high in 2011.

Boom peaking?

Prices tumbled 33 per cent this quarter for 62 per cent iron ore delivered to China’s port of Tianjin, heading for the biggest three-month decline since The Steel Index Ltd. started compiling data in November 2008. The raw material reached $88.70 per metric ton on August 30, the lowest since October 2009, according to the data.

Stevens told parliament August 24 that the mining investment boom may peak within one to two years. He spoke a day after Resources Minister Martin Ferguson told Australian Broadcasting Corp radio that “the resources boom is over.” The minister later said he had been talking only about the end of the boom in commodity prices.

Melbourne-based BHP sees “long-term” declines in raw materials prices, chief executive officer Marius Kloppers said August 26 on the Australian Broadcasting Corp.

Fortescue bonds

Iron-ore producer Fortescue Metals Group Ltd’s debt handed investors a 4.7 per cent loss in August, the most among 34 miners in Bank of America Merrill Lynch’s US High Yield Metals & Mining Index. The gauge gained 1.1 per cent.

The relative yield on Fortescue’s biggest line of bonds — $2.04 billion of seven per cent notes due 2015 — surged 162 basis points last week to 685 basis points more than Treasuries, the highest since November, according to data from Trace, the bond price reporting system of the Financial Industry Regulatory Authority.

Rio Tinto Group, Australia’s biggest iron-ore exporter, saw its credit-default swaps surge 47 basis points over the past two weeks to 172 on August 31, the highest in almost three months, CMA data show. BHP contracts jumped 25 basis points to 115 in the same period.

The Markit iTraxx Australia index of credit-default swaps that measures perceptions of corporate bond risk advanced 12 basis points last week to 169 basis points, the steepest climb since the five days ended May 18, according to CMA. The data provider is owned by McGraw-Hill Cos and compiles prices quoted by dealers in the privately negotiated market.

Tame inflation

The gap between yields on inflation-linked bonds and benchmark government notes shows investors estimate consumer prices will rise by an annual 2.48 per cent over the coming 10 years, the lowest breakeven rate since July 25. The RBA seeks to keep underlying inflation in a range of two per cent to three per cent.

Powering growth is a resource bonanza — for iron ore, coal and natural gas — and the nation’s jobless rate, at 5.2 per cent in July, is lower than 8.3 per cent in the US and more than 11 per cent in the euro area. Unemployment probably rose to 5.3 per cent in August, economists said before a September 6 report.

“The domestic labour market remains a risk, with timely indicators suggesting only modest growth recently,” said Paul Bloxham, chief economist for HSBC Holdings Plc in Sydney and a former RBA official. “International events are likely to dictate the RBA’s next move, in our view, and with global risks to the downside, we expect them to retain an easing bias.”

HSBC revised down its Australian growth forecasts for 2013 from 3.5 per cent to 3.2 per cent, while retaining its 2012 outlook of 3.3 per cent.