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Offshore Investors are falling out of love with Australian bonds

Australia, with rising government debt and a persistent current account deficit, relies on investment from the rest of the world to finance the economy.

But there is “waning interest in Australian bonds in recent years,” according to Katie Hill, Martin Whetton and Daniel Been from the ANZ.

In a note to clients the trio says that even though “in absolute terms, foreign holdings continue to rise” the fact that Australian government issuance has outstripped demand means “foreign holdings of ACGBs as a share of outstanding debt are at the lowest level since Q2 2009”.

In Q1 2016 foreign investor holdings dropped to 60.7% from 63.8% in the December quarter of 2015. That’s the 7th consecutive quarterly fall the ANZ says.

The ANZ said:

The falling proportion of non-resident holdings of ACGBs reflects both slowing demand and increasing supply. Non-resident holdings of ACGBs rose in absolute terms to AUD282.4bn in Q1 2016 from AUD278.5bn, but trend growth has clearly softened, with annual growth running at just 2.5% (down from 22.3% at end 2014). On the supply side, the AOFM’s borrowing task for 2016-17 remains significant with nominal ACGB issuance expected to total AUD90bn.

They say the waning demand “reflects lower returns amid the sharp drop in the AUD and narrowing yield differentials – particularly against US Treasuries”. This and the fact that FX reserves have been falling since 2014 means “Central banks and sovereign wealth funds have been an important buyer of Australian bonds in recent years, but now appear to have reached a peak in their accumulation”.

That makes the funding task of the Australian government a little harder. It also means
with Australian government deficits necessitating increased issuance in the years ahead it will be left to the local banking system and investors to take up the slack.

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