Sovereign Pain Trade Drives Best Aussie Bond Gains in a Year

May 29, 2014 10:10 pm ET

(Updates prices, adds auction from second paragraph.)

May 30 (Bloomberg) -- Easy money is feeding a global rally in bonds that drove Australia’s sovereign debt to the best month in more than a year and the nation’s largest lender says the “pain trade” is poised to continue.

Government bonds have returned 1.43 percent this month, the biggest gain since April 2013, the Bloomberg Australia Sovereign Bond Index shows. A gauge for U.S. Treasuries rose 1.11 percent, while one for German government securities climbed 1.04 percent, the data show. An auction of Australian bonds today drew the most interest since November 2012.

Commonwealth Bank of Australia sees prospects the rally will continue with retail spending vulnerable to a downturn after an austere federal budget that’s weighing down interest- rate expectations and consumer confidence. The nation’s debt offers the highest yield after New Zealand’s among major developed economies with an investment-grade rating. That’s enhanced the allure of the securities as signs of an extended period of accommodative policy in Europe and the U.S. prompt investors to seek assets with better returns.

“There’s been a big pain trade in terms of investors who’ve been short bonds getting squeezed and covering those positions and right at the moment it’s hard to see a rapid turn around in that,” Adam Donaldson, the head of debt research at Commonwealth Bank, said yesterday. “There doesn’t seem to be anything stopping that at the moment. Fundamentally we think the market is expensive and that’s a constraint.”

RBA Outlook

Australia’s benchmark 10-year yield was at 3.66 percent as of 11:55 a.m. in Sydney, after yesterday touching an 11-month low of 3.61 percent. The three-year rate was 2.75 percent, having dropped as low as 2.71 percent yesterday, the least since September. The Australian dollar traded at 93.17 U.S. cents, up 0.3 percent since April 30 and poised for a fourth-straight monthly gain.

A sale of Australian government bonds today maturing in October 2018 attracted 5.93 times as many bids as the amount offered, according to Australian Office of Financial Management. The government sold A$700 million ($652 million) of the notes at a weighted average yield of 3.06 percent.

Swaps traders are seeing almost no chance of a central bank rate increase in Australia over the next 12 months after predicting an 88 percent probability in April, a Credit Suisse Group AG index shows.

The Reserve Bank of Australia is scheduled to announce its monthly policy decision on June 3, with the statistics bureau due to release April retail sales data earlier that day.

ECB, Fed

Private-sector credit grew 4.6 percent in April from a year earlier, the fastest pace since 2009 and beating the median forecast for a 4.5 percent rise, RBA data showed today.

Commonwealth Bank lowered its bond yield forecasts on May 28 and now sees Australia’s 10-year rate rising to 4.10 percent by the end of 2014, down from a previous estimate of 4.70 percent. The median forecast in a Bloomberg survey conducted May 8 to May 13 was for 4.50 percent at year-end. The three-year yield will be at 3.4 percent by Dec. 31, the bank estimates.

President Mario Draghi signaled May 26 that European Central Bank policy makers are ready to take action in June should they see low inflation becoming entrenched. Federal Reserve policy makers said in minutes of an April 29-30 meeting that continued stimulus to push U.S. unemployment lower doesn’t risk sparking an undesirable jump in inflation.

The yield premium Australia’s 10-year bonds offer over German bunds was at 229 basis points, from this year’s high of 263. The gap over U.S. Treasuries of similar maturity was 120 from as high as 153 on March 13.

“We continue to think that the market is underpricing what the Fed will do next year, both the timing and the scope,” said Donaldson. “But, it’s become abundantly clear that nothing is happening in the new few months and the market is happy to undertake these carry trades and stay invested.”