Will borrowing costs hit the Budget?

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The AFR has story about the concern that rising long bond yields will hit the Budget:

Foreign investor demand for Australian government debt fell at Wednesday’s bond auction with the number of bids per offer around half of what it was earlier in the year, according to Treasury bond tender documents.

The drop in demand potentially undermines the government’s slated $62 billion record issuance for this year…

…Tyndall Investment Management head of fixed income Roger Bridges said that while demand has fallen for long dated bonds, bids for short paper was strong, especially among global central banks.

“The issue is that long paper has become much more expensive compared to short paper. Last year it was half the spread it is today. Demand for short paper is coming from people taking a bet on the currency rather than looking for the interest rate risk of a long bond.

“Into last year, the government had falling interest rates and excess demand for their paper, what has happened is the reduction in Euro concerns and reduction in flight to safety buying means there is not the massive demand for paper that there was last year. In addition the fact the Australian Dollar has fallen by nearly 10 per cent adds to the nervousness of buying long paper with the possible associated currency and interest rate risks.”

There’s no doubt that borrowing costs have been rising. The ten year yield is up 30% or so since April as the safe haven bubble burst:

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But as I’ve been arguing, I do not think that the Fed is going to taper now for some time. Even without the shutdown, the US economy is slowing so bonds are going to become more attractive for a while. We are already seeing this in the rising Australian dollar, which is up at this week’s high today around 94 and half cents.

Still, if folks are going to park at the short end of the curve while they wait for the shutdown to pass and taper discussions to resume then there is no doubt that Australian long bonds will continue to sell off over the medium term. At some point you would expect this to filter through as well to bank funding costs. Like the sovereigns, yields on wholesale debt are up roughly 30% since the lows of April. They went much higher during the June China interbank scare but are back at reasonable levels now.

If we expect a credit-led recovery amid the Fed taper then bank supply is also likely to rise as deposits run low.

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Either way, in the medium term higher funding costs are likely coming.

About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.