RBA Doves Cry Anew as Fed Hawks Seen Circling: Australia Credit

Jun 29, 2014 8:29 pm ET

June 30 (Bloomberg) -- Australia’s bond yield advantage to the U.S. has narrowed to an 11-month low as traders see the Reserve Bank of Australia renewing a dovish tone even as the Federal Reserve prepares to tighten policy.

The yield premium Australian 10-year notes offer over U.S. debt of similar maturity shrank to 1.03 percentage points June 27, the least since Aug. 1, from this year’s high of 1.53 in March. Bets the RBA, which meets tomorrow, will reduce interest rates by year-end climbed as high as 28 percent last week from 9 percent on June 13, swaps data compiled by Bloomberg show.

Governor Glenn Stevens is grappling with how much a record- low 2.5 percent cash rate will offset a drop in mining investment and a tighter budget, particularly as the currency provides less assistance to rebalancing economic growth. The nation’s housing boom has cooled, and business and consumer confidence remain subdued as indebted households hunker down.

“We’re going to be left with weak income growth and a pretty soft consumer over the next quarter or so,” said Peter Jolly, Sydney-based head of research for National Australia Bank Ltd. “The Fed is still on a path to lift interest rates while, in Australia, the bias remains toward easing if the RBA moves at all over the next 12 months.” He said weaker data could push up bets on a cut by year-end to 50 percent.

Some Time

Traders were pricing on June 26 a 55 percent chance the Fed will raise its key rate to at least 0.5 percent by July next year. A Credit Suisse Group AG index based on swaps shows five basis points of easing expected from the RBA over 12 months.

Economists forecast no change at tomorrow’s meeting or the one after, according to a Bloomberg survey. The RBA said in minutes of its June meeting that the current accommodative stance of policy was likely to be appropriate for some time.

In contrast, James Bullard, president of the St. Louis Fed, said June 26 the U.S. economy is improving enough to withstand an increase in short-term interest rates next year as growth picks up. The Federal Open Market Committee is debating how long to keep the benchmark near zero as it pares bond purchases.

The RBA cut its cash rate by 2.25 percentage points between late 2011 and August to boost industries including residential construction. Dwelling prices climbed 10.7 percent across eight state and territory capitals in the 12 months to May 31 to a median A$545,000, the RP Data-Rismark home value index shows.

Prices fell 1.9 percent in May, the biggest monthly drop since December 2008, as spending cuts and tax increases in the federal budget announced last month weighed on homebuyers.

The yield on two-year government bonds on June 27 fell below the cash rate for the first time since September.

Better Hiring

Stimulative policy has spurred hiring, with unemployment holding at 5.8 percent for the past three readings, after reaching 6 percent at the start of the year. Coles supermarkets and Woolworths Ltd. are among companies adding jobs.

RBA board member John Edwards said in a paper released last week that Australia can weather the slump in mining investment, and Japan could return as the nation’s biggest trading partner, spurred by increasing liquefied natural gas exports.

Replacing 2 percent to 3 percent of gross domestic product with non-mining sources of growth over five to six years will be “onerous but not difficult,” Edwards wrote in the paper for the Lowy Institute titled “Beyond the Boom.” A weaker currency would also help, he said.

Language Shifts

In its June minutes, the RBA forecast below-trend growth for the rest of 2014 and into next year as “substantial falls” in mining investment and weaker government spending weigh on the economy. Australia’s dollar, which traded at 94.36 U.S. cents as of 5 p.m. on June 27, has risen 7.8 percent since the central bank adopted a neutral bias in February, erasing part of a 14 percent drop last year.

The RBA has “scope for shifts in language to convey a somewhat less optimistic tone,” Bank of America Merrill Lynch’s Chief Australia Economist Saul Eslake, wrote in a June 27 note. “In our view this may occur as the activity data flow soften over coming months.”