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Feb. 17 (Bloomberg) -- Australia’s central bank is signaling its success in weakening the currency will spur inflation, adding to pressure on the developed world’s worst- performing bonds.
A surge in yields since Feb. 4 pared returns for the past six months to 1.2 percent, an index of debt due in more than a year shows, the smallest gain of 22 advanced-economy markets tracked by the European Federation of Financial Analysts Societies and Bloomberg. Inflation may reach a two-year high 3.25 percent, the Reserve Bank of Australia said this month. Assistant Governor Christopher Kent said Feb. 14 accelerating economic growth may drive costs higher.
The real yield on Australian bonds after accounting for inflation will be less than what investors earn from Treasuries if the RBA is correct. Policy makers raised output and inflation forecasts after the currency weakened 14 percent in 2013 and housing costs rose to a record. The figures boosted odds RBA Governor Glenn Stevens’ next move will be to increase rates.
“Tightening seems more possible than easing,” said Park Sungjin, who oversees $7 billion as the head of asset management in Seoul at Meritz Securities Co. He’s staying away from the nation’s bonds, he said.
The RBA dropped its easing bias at the Feb. 4 policy meeting and said inflation last quarter was stronger than expected, possibly because the impact of a lower exchange rate was being passed on more rapidly than anticipated.
Benchmark 10-year yields rose five basis points, or 0.05 percentage points, to 4.15 percent as of 11:23 a.m. in Sydney. The yield was 1.41 percentage points more than what investors get from Treasuries, compared with the average of 1.37 percentage points over the past six months.
Australia’s dollar advanced 0.2 percent today to 90.49 U.S. cents. It is 0.4 percent away from its highest level this year.
If the RBA’s projection of 3.25 percent inflation proves correct, Australian 10-year real yields would be 0.9 percent. The figure is 1.25 percent in the U.S. It would also see inflation exceed the central bank’s target range of 2 percent to 3 percent.
Stevens reduced the benchmark interest rate, the target for overnight loans between banks, to a record 2.5 percent in 2013. The aim was that low borrowing costs would work with a weaker currency to stimulate consumption, construction and exports.
The so-called Aussie ranked No. 14 among the 16 biggest currencies last year, with only the Japanese yen and the South African rand falling more, data compiled by Bloomberg show.
The result was eight straight months of rising housing costs in Sydney that have pushed prices to a record, based on the RP Data-Rismark Daily Home Value Index.
The RBA’s Kent said Australia’s weaker exchange rate will help accelerate the country’s return to trend economic growth and is likely to spur inflation for a period, in the text of a speech last week in Sydney.
Kei Katayama, a bond investor in Tokyo at Daiwa SB Investments Ltd., which oversees the equivalent of $48.3 billion, said Australia’s high yields are reason to invest.
Bonds in the Bloomberg Global Developed Sovereign Bond Index yield 1.43 percent, versus 3.50 percent for the Bloomberg Australia Sovereign Bond Index.
The nation’s top-level debt ratings from Moody’s Investors Service and Standard & Poor’s Corp. are another plus, he said. The U.S. is ranked one step lower by S&P at AA+.
“The Australian fixed-income market is very attractive within the global fixed-income market,” Katayama said. “The global inflation situation is very calm,” which will help keep prices in check in Australia, he said.
Katayama said he is keeping his holdings of Australian bonds in line with the benchmark he uses to gauge performance.
The country’s bonds trimmed losses Feb. 13 after a government report showed the unemployment rate rose to 6 percent in January, the most since 2003. Swaps traders priced in 10 basis points of RBA rate increases within a year on Feb. 14, down from 18 a week earlier, according to an index from Credit Suisse Group AG.
Investors should buy the Australian inflation-linked bond due in August 2015 as a hedge against rising costs, Sally Auld, a Sydney-based interest-rate strategist at JPMorgan Chase & Co., wrote in a report last week. The bond’s capital value moves in tandem with the consumer price index, and interest is paid on the adjusted value.
Bonds in the Bank of America Merrill Lynch Australia Inflation-Linked Government Index returned 1.5 percent over six months as of Feb. 14, compared with 1 percent for a similar index of notes that don’t adjust for consumer-price gains.
Australia & New Zealand Banking Group Ltd. in Sydney predicts the central bank will begin raising interest rates around March 2015.
“Barring any further shocks in the Aussie economy or any sort of breakdown in emerging markets or China that will flow on to Australia, the RBA’s easing cycle is over,” said Zoe McHugh, an interest-rate strategist at the bank. “The risk is more toward a hike this year than toward a cut.”
--With assistance from Kristine Aquino in Singapore. Editors: Garfield Reynolds, Jonathan Annells