Bloomberg: Australian bonds are vulnerable due to the RBA’s policy easing

Source: Bloomberg

Authors: Swati Pandey and Garfield Clinton Reynolds

Article: Original article

Publication date: Thursday, December 15, 2022

Sally Auld, chief investment officer at JBWere Ltd. said that Australian financial assets, bonds included, could fall in price in 2023, as the Reserve Bank of Australia’s (RBA’s) easier approach to fighting inflation might have some negative consequences.

Auld refers to the RBA’s decision to slow down the pace of rate hikes in an attempt to maintain job growth. She stated that it looks good in theory, but there is a risk of another rise in inflation expectations that the bank has to take if it uses this strategy.

The RBA has taken a more dovish position than its counterparts in other countries, who have made a clear decision on fighting inflation even at the risk of recession. The RBA’s position spurred the growth of Australian government bonds from outsiders to leaders.

Last month, 10-year Australian bond yields dropped by 31 basis points compared with the U.S. counterparts, the lowest level since the pandemic in 2020.

Another reason for rising bond prices is a growing market expectation that RBA Governor Philip Lowe may take a less hawkish approach without raising inflation expectations.

At the same time, Auld notes that it’s quite possible that in the upcoming year the RBA will realize that it has “more work to do”. According to her opinion, the current interest rate of 3.1% will peak at 3.6% in line with market prices and economists’ predictions.

This week’s data on the Australian labor market showed that hiring keeps being steady and the unemployment rate holds at its 48-year low, thereby highlighting the risk that inflation could remain high.

Money market demonstrates that Australian rates will be higher than 3% in around 2-3 years. It’s comparable to expectations of U.S. rate cuts to 2.84% over 3 years.

Auld stated that such an environment doesn't give as many opportunities for 10-year Australian bonds to significantly exceed U.S. Treasuries.

She also believes the Australian dollar will be under pressure in the following year, "struggling" to break through the level of 75 U.S. cents because a global recession will probably be the first thing the world will face in the first half of 2023.

It’s hard to be optimistic about high-risk currencies when the global GDP growth causes lots of concerns, she added. But 2023 is likely to become an end for the U.S. dollar dominance.

According to Auld, the risk of recession in Australia remains crucial for the second half of next year as well, which might put even more pressure on the Australian dollar.

Forecast: AUDUSD is likely to decline