Aussie bonds go boom

Boom! Aussie bonds broke out at the short end last night and are right at the launch pad for the long:

The driver is easy enough. The RBA is going to capitulate and cut twice this year, via Macquarie:

“Picking the timing of rate cuts is a little tricky. If the Bank sticks with Statement months to change policy then May or August is our best bet for the initial easing.

A May cut may be too soon if the Bank feels it wants more clarity on the data flow — particularly the labour market — and it would be just prior to the federal election, though we aren’t sure that would be a relevant issue for the Bank.

The main catalyst for the change of view is that we cannot see what the downside risks are to easing policy further. Take the path of least regret.

Importantly, we are strongly not of the view that central banks should ‘keep their powder dry’ in case growth turns out to be weaker down the track.

If additional policy support is necessary then it should be provided — best to provide it early than have to take more drastic action if growth actually turns down sharply.

We also do not support the view that cutting the cash rate from here would provide little economic support.

Cash rate cuts would be substantially passed through to actual lending rates — including those on existing loans — in our view.

If they aren’t, the Bank can cut by more. The Australian dollar would also be lower.

In the event of a sharper downturn, Australia retains ample fiscal ammunition to respond and unconventional policy tools — including QE — are also available.”

It is my view that monetary transmission is impaired, by household debt and a blown BBSW spread, so banks will hold much of the first two cuts back and they will not have a great impact on domestic activity. Supporting this supposition, markets are yet to steepen the curve at all:

I see two more rate cuts to follow in 2020 and QE longer term as China keeps slowing and Australia’s income woes worsen.

For me, therefore, the play remains long bonds with the 10 year headed for a record low yield near 1% as the cash rate sinks to 50bps. That will also, of course, put serious pressure on the Aussie dollar via spreads:

I still think this does not end until the battler returns to its millennial lows.


David Llewellyn-Smith is chief strategist at the MB Fund and MB Super which is long international equities and local bonds that will benefit from a weakening Australian economy and dollar so he is definitely talking his book.

If the ideas above interest you then contact us below. 

Comments

  1. “It is my view that monetary transmission is impaired, by household debt and a blown BBSW spread, so banks will hold much of the first two cuts back and they will not have a great impact on domestic activity.”

    Banks making record profits by using RBA cuts to pad their margins in a collapsing housing market, presumably with unemployment and defaults piling up? The new era of customer focus. I don’t think they would want to try that under an ALP government.

    • Dan, buying long dated government bonds wasn’t such a hopeless prediction after all.

      It seems that many people have jumped on board the bond wagon.

      • Andrew please point out to me the post where I said that was a hopeless prediction. You keep it on your fridge don’t you?

    • +1, but no point asking what should happen, only what will happen.

      Take it you’re short the banks? They can’t continue to rally into this thing. They’re mortgage lenders selling mortgages to people who can no longer afford to pay them.

      • Is it beyond the realms of possibility for bank profits to fall? This seems to be the common assumption, but they are among the highest in the world.

        They will face a choice of cutting mortgage rates, or rising impairments. They will get taken to pieces if they held on to RBA cuts in a situation where people were losing their homes.

        Also can’t understand why you keep calling for rate cuts to help the economy, but its all going to go to shore up bank profits, not the people struggling with debt?

    • I’m thinking banks have one last flush higher to really clean out the shorts. I am thinking it will happen on the back of a yield play. CBA to hit $85.

      • Profit warnings left, right and centre. Consumers getting punished on every front. Falling asset prices. No wage growth. Rising household credit delinquencies. We haven’t even seen employment get smacked yet (RBA will not cut until this happens; too late for the banks).

        I’ll eat my shorts if we get to $85. Mark this post.

      • Well there’s always the “bad news is good news” trade, at least until the first RBA cut is fact.But I think more depends on US markets which are at an important technical level and could roll over. CBA is a stock used to drag the index and doesn’t always reflect banking fundamentals so much as the others. I doubt it can go much higher if the SPX resumes falling.

      • Keep in mind that there is the AUD down = ASX up trade?

        Why? Dunno, but that’s what’s been happening, cause that’s what happens overseas, and kangaroos…

        Watch out for the unintended consequences of the Poo! I’ve already been burnt by trying to short stocks that should, in theory be going down, but get propped up by AUD-down rallies, or so it seems….and am now hedging…

  2. DanMEMBER
    November 21, 2018 at 9:46 am

    Lulz.
    .I remember you calling bonds a buy for a couple of years now. Not only have you been hopelessly wrong all this time you come on here to gloat at first sign of a correction with yields still near multi-year highs.

    Guessing you are just a paper trader which is why you haven’t had a lesson in humility meted out by the market.

    • Yes Andrew -but where does it say buying long bonds is a hopeless prediction?

      All my posts on markets have a timeframe, which for me is sometimes quite short. I was bearish USTs at the time that UST yields were rising. Now I am not.. I’ve never commented about Aussie bonds so you won’t be able to locate such a post, don’t bother trying. And don’t come back and gloat years after a market related post under the assumption I am still holding the same position Unlike some here, I’m not a perma-anything.

  3. “And Lowe will move on to give after-dinner speeches for $250,000. The Lucky Country indeed (for some).” LOL

  4. Dan, I kept it on my fridge only to remind me why I back my own judgement.
    There might be a few Dan’s on this site, so if this is not you, my apologies.
    It is no big deal one way or the other.
    It just gave me a bit of a chuckle.

  5. Denis413MEMBER

    If it will have minimal impact due to elevated debt and banks wont pass on the cut, why cut?

    • proofreadersMEMBER

      The RBA is a useless one-trick pony – beginning and end of story. The RBA is well past its use-by date.

    • That doesn’t matter, the show must go on……or we might have to face reality. Look at Denmark…….government sourced mortgages for 30 years at fixed 1.5 % interest…….coupled with negative deposit rates. We will be in a similar place in 10 years time………..the alternative is unthinkable to those holding the reins of power.