The cleanest of dirty shirts

What have Australian government bonds been doing and what’s likely to happen once  the federal government returns to surplus, as planned?

For context, here is how the 10 year bond yield has performed in the last 5 years (click here for a very long term study):

Just a reminder, when bond yields fall, the actual price rises – this indicates higher demand for the bond – here’s the price chart since April 2010:

In the case of Aussie bonds, the rising price its almost all because of foreign demand (chart courtesy of the Bond Vigilantes), currently over 76% of ownership:

Why are foreign investors the main buyers? Firstly, the domestic obsession with (underperforming) shares and secondly, in a world of “dirty shirts”, Aussie’s are the cleanest, with a low government debt to GDP ratio (27%), relatively high interest rates and strong employment. This is how PIMCO – the worlds largest bond fund – recently described the situation:

From an investment perspective, we believe Australia’s strong initial conditions should help ensure that Commonwealth Government Bonds remain one of the world’s “cleanest dirty shirts” for risk-averse investors, especially as the federal budget moves back into surplus and issuance levels reduce. This tightening fiscal position will likely result in interest rates staying lower for longer, the Australian dollar weakening from current levels and continued margin erosion for corporations operating in globally exposed non-mining sectors.


Note that PIMCO has reduced its GDP growth target to 2.75 to 3.25% whereas the latest survey of economists has 2012 and 2013 real GDP growth at 3.3% for both years. BT Investment (owned by Westpac), which is also bullish on Aussie bonds, has expectations at only 2.5% – from Bloomberg:

Australia is clearly slowing. We don’t know how there hasn’t been any downgrading in expectations over the last three months, given the data pulse has been materially weaker. There’s still value in Australian bonds…

BT Investment holds more Australian government bonds and less corporate debt than the benchmark it tracks. It’s buying infrastructure and utility bonds as they are likely to outperform as the economy slows.

The futures market as of this morning has priced in a full 100 basis points (1%) cut in official interest rates by early 2013 and if the Consumer Price Index (CPI), which comes out next Tuesday, prints low, the cuts may be on their way sooner rather than later. Whether Megabank passes on the cuts, in full or in part, is another question, but it certainly will impact bond and share prices.

There are risks against a continuation of the bull market in bonds, as ever. If the RBA cut’s rates too quickly or does not leave enough in reserve (sic) against future crisis or an inability of the government to maintain its AAA rating if it fails to return to surplus, we could see a sharp reversal in capital inflows as Australia’s “cleanest” haven status becomes more than just spotty.

In the chart above a high correlation is evident between foreign ownership of government bonds and the Aussie dollar (recent reversals against the major currency pairs I covered here from a technical point of view), which makes sense, given the exogenous forces applied to our economy, including a dominant trend that a growing China will always benefit Australia.

If all things go to plan, with an automatic reduced supply as the government swings from deficit to surplus, therefore continued foreign demand as the gleaming AAA rating is maintained, the RBA will have to supply just the right amount of starch to ensure the bull market of these “cleanest of dirty shirts”.

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  1. aussie bond yields below peak GFC lows? hmmmm….who to believe, bond market or RBA?

    ill take the bond market and 100 bps worth of rate cuts thanks.

  2. Probably a technical thinggy…but why does the 10 year Bond graph say ” 5 Year Bond’ when it’s moused over?

    • Because he stuffed up the file naming of the screenshot at a guess. You can see it is the 10yr bond (ACGB July 2022) at the bottom of each screenshot. He is still on his Bloomberg L-plates.