As regular reader will know, I have wagered the universe that the next move in interest rates will be down or I will run naked up a mountain. This has been an increasingly lonely position of late as more and more analysts have been drawn into Australia’s bull trap and markets have shifted the curve to just one more cut around August.
But today my trousers receive some very welcome and high powered support from no less that the world’s largest bond fund via the SMH:
Bond giant Pimco says debt markets are misguided to bet the Reserve Bank is almost finished cutting interest rates, arguing that the economy will struggle to cope as a resource investment boom fades.
“The big economic uncertainty arrives when the economy transitions from an investment destination to a production and export engine,” said Robert Mead, Sydney-based head of portfolio management at Pimco, which runs the world’s biggest bond fund. “This transition will not be smooth.”
The Reserve Bank of Australia is expected to lower the overnight cash rate target to 2.75 per cent from 3 per cent by December 31, according to the median forecast of 29 economists surveyed by Bloomberg News.
…Pimco is investing in longer-dated swaps, state government bonds and high-quality corporate notes as markets. These markets had priced in an “unrealistic series” of rate cuts, and are now probably not pricing in enough, said Mead.
The fund manager, which oversees $US2 trillion worldwide, expects the Australian economy to struggle towards the end of 2013 and early next year as growth moderates in China, the nation’s largest trading partner. The RBA predicted “below trend” 2013 growth of about 2.5 per cent on February 8, slowing from 3.5 per cent last year.
“We estimate transition somewhere between fourth quarter 2013 and second quarter 2014, depending on projects being on time et cetera, so the growth uncertainty will increase over this period and the market will start to anticipate this uncertainty well in advance,” Mead said in response to e-mailed questions.
The extra yield 10-year swap rates offer over similar- maturity government debt was 50 basis points yesterday, compared with a 26-basis-point gap for three-year securities, Bloomberg data show. Pimco isn’t buying Australian sovereign debt, Mead said.
“The offshore bid for Australian assets was predominantly in Commonwealth government bonds, so they became relatively expensive versus other, high-quality alternatives,” he said. “We are focused on the carry benefit of these assets in what we expect to be a fairly benign credit market for high-quality borrowers,” Mead said with regard to swaps, state government and corporate notes.
…”With the mining investment cycle passing its peak, plus the elevated Australian dollar, there remains a limit in terms of how high Australian yields can go, especially given the retracement we have seen since fourth-quarter 2012,” Mead said. “The starting level of real yields and the economic fundamentals will eventually lead to outperformance of Australian bonds versus other developed markets.”
…”The RBA has not finished their cycle, unless of course we see a significant drop in the Australian dollar or an abandonment of fiscal discipline,” Mead said.
Right on all fronts.
