The last time Australian economic data were this disappointing, bonds staged the biggest rally in almost five years.

The Citi Economic Surprise Index, which measures the strength of the data relative to analysts expectations, shows they are missing forecasts by the most since the second quarter of 2012. The debt market surged 5.6 percent in that period, the most since the three months ended September 2011, based on the Bloomberg Australia Sovereign Bond Index.

Consumer-price increases, retail sales, wages and home loans are all falling short of what economists forecast, though March employment beat expectations. The Reserve Bank of Australia will probably reduce its benchmark interest rate again this year, after cutting it to a record low this week, futures contracts indicate. RBA Governor Glenn Stevens said the outlook for inflation is lower than previously forecast in his statement accompanying the rate decision.

“Deflation pressure should materialize,” said Hideo Shimomura, the chief fund investor in Tokyo at Mitsubishi UFJ Kokusai Asset Management, who said he’s bullish on the nation’s bonds. “Domestic growth is slowing.”

Record Low

Benchmark 10-year yields will tumble to a record low of 2 percent by year-end, Shimomura said, from 2.43 percent Wednesday. The central bank’s benchmark will be less than 1.5 percent, he said, falling from 1.75 percent.

Mitsubishi UFJ Kokusai is the largest owner of Australia’s debt after Vanguard Group Inc. among those holders required to make regulatory filings, according to data compiled by Bloomberg.

The RBA will update its growth and inflation forecasts on May 6.

The difference between yields on 10-year notes and similar-maturity inflation-linked bonds shrank to 1.8 percentage points on Wednesday, an all-time low based on closing prices in Bloomberg data that go back to 2000. The so-called break-even rate is a gauge of trader expectations for consumer prices over the life of the securities.

Australian government bonds have returned 3.2 percent this year, matching U.S. Treasuries, according to Bloomberg World Bond Indexes.

Bovingdon’s View

While short-term securities will draw support from the central bank rate cuts, it’s a different story for benchmark 10-year bonds, said Bill Bovingdon, the chief investment officer at Altius Asset Management in Sydney, who has 30 years of experience in fixed income.

“We’re not so keen on the long end” because it will be driven by Treasuries, Bovingdon said. “We’re still constructive on the U.S. economy. Given that there’s nothing priced in there in terms of rate hikes for the foreseeable future, there’s a potential for a bit of disappointment there.” Australia’s 10-year yields will become attractive if they rise to 2.75 percent, he said.

Bovingdon is in a minority, judging by yields.

Demand for 10-year bonds cut the yield premium over similar-maturity Treasuries to 63 basis points this week, the narrowest since March.

Source:
courtesy of BLOOMBERG

by Wes Goodman

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