World’s Best Bonds Ride Aussie High-Yield Wave: Australia Credit

Jul 03, 2014 2:01 am ET

July 3 (Bloomberg) -- Australian bonds delivered the world’s biggest gains to global investors last quarter as the local currency rose. BNP Paribas Investment Partners is betting relatively high yields will spur further gains.

An index of government securities due in more than a year returned 5.5 percent including currency appreciation versus the U.S. dollar, the most of 26 markets tracked by Bloomberg and the European Federation of Financial Analysts Societies. The Aussie Bloomberg Correlation Weighted Index rose 1.6 percent from the start of April through June, completing the first back-to-back quarterly gains since 2010.

“I am positive on the Australian dollar,” said Naruki Nakamura, the head of fixed income at BNP Paribas Investment in Tokyo. “Australian dollar investment including the carry should be quite attractive. The short-term interest rate is higher among the major currencies.”

The Aussie climbed to its highest level in almost eight months this week versus the U.S. dollar after Reserve Bank of Australia Governor Glenn Stevens signaled July 1 that investors can rely on the central bank’s 2.5 percent rate, second only to New Zealand’s among major developed nations. Investor demand at sovereign bond auctions last quarter was the strongest since 2012. Stevens warned today that investors are under-estimating the probability of a “significant fall” in the currency.

The Australian dollar fell 0.6 percent today to 93.87 U.S. cents as of 11:39 a.m. in Sydney. It touched 95.05 on July 1, the strongest level since November. The average for the past decade is 87.84.

Aussie Bets

Nakamura has been betting on the Aussie since February, he said in a telephone interview July 1. He predicts it will trade in a range of 95 U.S. cents to $1 by year-end. BNP Paribas Investment Partners manages the equivalent of $668 billion globally, according to its website.

Australian bonds also had the best returns for yen- and euro-based investors at 3.6 percent and 6.1 percent, the data show.

Benchmark 10-year bonds yielded 3.55 percent, following a 54-basis-point drop last quarter, the most in two years. Investor demand pushed the yield down to 3.52 percent last week, the lowest level in a year.

The premium over U.S. Treasuries narrowed to 93 basis points, a level not seen since 2006.

Auction Demand

Investors in the government’s nominal debt auctions bid for 4.2 times the amount available on average during the last quarter, the most since the end of 2012, data from the Australian Office of Financial Management show.

Though Australia’s yields are attractive, the currency is expensive, said Zeal Yin, a Taipei-based trader at Shin Kong Life Insurance Co., which has asset equivalent to $84 billion.

“The level in the very short term is a little high,” he said. Yin would like to buy the Aussie at about 93 U.S. cents and the currency may gain to 97 U.S. cents by year-end, he said in a telephone interview July 1.

The Aussie will decline to 90 cents by Dec. 31, according to the median of estimates compiled by Bloomberg.

“Most measurements would say it is overvalued, and not just by a few cents,” the RBA’s Stevens said in the text of a speech today. “We think that investors are under-estimating the likelihood of a significant fall in the Australian dollar at some point.”

The currency weakened yesterday after the government reported that the trade deficit expanded to A$1.91 billion ($1.8 billion) in May, matching the largest since November 2012.

Next Move

Stevens reiterated this week that he foresees “a period of stability in interest rates,” amid declining mining investment and inflation that is expected to remain consistent with the central bank’s target over the next two years.

Swaps traders are pricing in a key rate five basis points lower over 12 months, a Credit Suisse Group AG index shows.

While the RBA’s benchmark of 2.5 percent is at a record low, it compares to the Federal Reserve’s target range of zero to 0.25 percent. The Bank of Japan’s main rate is close to zero, and that of the European Central Bank is 0.15 percent.

Hedge funds and other large speculators boosted bullish bets on the Aussie. Net longs rose to 33,463 in the week through June 24, the most in 14 months, compared with 15,848 on May 27, Commodity Futures Trading Commission data show.

The RBA’s next move will be to raise interest rates, said Joseph Capurso, a Sydney-based currency strategist at Commonwealth Bank of Australia. The Aussie will climb to 97 U.S. cents by Dec. 31, he said.

“We’ve still got a very strong conviction that the market is underpricing RBA rate-hike risks, and that’s eventually going to be very supportive of the Aussie, probably toward the end of the year,” Capurso said in a phone interview yesterday. “If the RBA doesn’t start hiking rates at the end of the year, then it will be early next year.”