Australian bond rates are back at all time lows and the rally may only just be getting started

Even though the ASX200 has rallied strongly and the S&P 500 is near its all-time high, Australian 2 and 10 year bond rates are back near their lowest levels in history, trading at 1.51% and 1.85% respectively as the global reach for yield continues.

In many ways, the continued rally in bonds is remarkable. But there are signs that it is likely to continue.

Robert Mead, managing director and head of portfolio management at PIMCO in Sydney, wrote earlier this month that “as we close the books on another Australian financial year, we make a striking observation: Over the last eight financial years, bond returns have exceeded equity returns on average by over 250 basis points per annum”.

That bond market outperformance came with “almost one-fifth of the volatility of equities”, Mead said.

Like bond rates all over the world, Australian 10 years, and the entire yield curve, have been rallying for 30 years.

Australian Government 10 year bonds (Reuters Eikon)

But there are signs that even at all-time lows, the rally in Australian bonds could continue.

With a bias to ease, the RBA can shift the anchor point from which 2 and 10 year bond rates are set.

Likewise, with more than $12 trillion in sovereign bonds across the developed world currently having negative yields, Australian bonds continue to look extremely good value on a relative value basis. That’s particularly the case given Australia’s AAA credit rating.

PIMCO’s Mead says other domestic factors will also play a role. He says Australians are under-invested in bonds.

“According to the Willis Towers Watson Global Pension Assets Survey 2016, the average Australian pension portfolio allocated only 14% to bonds, well below other developed market counterparts like the U.S. (23%), the U.K. (37%), Canada (31%) and Japan (57%)”, Mead says.

That means that as Australia – like the rest of the developed world – ages there is likely to be “increasing focus on stable retirement income, bodes well for a healthy dose of bonds in Australian investors’ portfolios in the years to come”.

It’s also likely to keep Australian bonds relatively well bid.

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