UBS: Australian bonds at current levels are almost a sell

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Australian government bonds are nearing levels where UBS Asset Management will be a seller.

The fund manager, which manages more than $26 billion, has already reduced duration on the government bonds, and is awaiting a trigger that could drag yields lower and push UBS Asset to sell, according to Anne Anderson, the head of Australian fixed income.

Bond yields move inversely to price.

Australian bonds yields have “moved to a level where they aren’t offering great value,” Anderson said.

“I’m waiting for another sign. The data is printing weaker and investors are pessimistic but something that provides momentum for bonds then the trigger is there.”

Aussie 10-year bond yielded 2.42% on Wednesday. While that is up from the all-time low of 1.84% in July, the yields almost touched 3% in April. The rate has retreated as investors cut risk amid mixed economic data and troubles plaguing the Trump administration.

The yield premium the nation’s benchmark bonds offer over their US peers stood at 21 basis points up from 16 basis points last month, the narrowest since 2001.

UBS went long in terms of duration in Australian bonds late last year and added to it this year when it didn’t agree with views that the Reserve Bank of Australia will likely tighten in 2017. It has reduced duration as it took profits after markets and priced in a small probability of a cut. It still hasn’t gone short though.

Futures are pricing in an almost one-in-five chance of a rate cut by the end of this year by Australia’s central bank.

“The best market to go short is the US Treasuries. Yields could rise beyond the next few months as more clarity around the Trump policy execution emerges and the downside surprises in data work their way through,” Anderson said.

Rates markets are now starting to price in the rising execution risk in US given the push back against Trump’s measures.

Trump is struggling to convince Congress to support his proposals, and the Republicans need the support of the Democrats to get spending plans through the Senate. Economists have also questioned the administration’s growth assumptions, which exceed most independent estimates of America’s likely sustained growth rate.

Still, Anderson expects the Fed to raise rates this week and move once again in September or December.

With the RBA expected to stay on hold, the Fed’s tightening would mean the yield premium Australian bonds offer over their US peers could vanish for the first time this century.

At this moment, the next move by the RBA is “most likely to be down but they would do it very reluctantly,” she said. “Part of that is because even if it were to ease, the banks are unlikely to pass on the full cut.”

The reduction in yield spreads along with record debt issuance by the Australian government to bridge repeated blowouts in the budget deficit has already had an impact on foreign ownership of nation’s bonds.

While non-resident holding of Australian government securities climbed for the first time in 11 quarters, the ratio is way lower than its 2012 peak. Foreigners held 55.4% of the $530.8 billion in outstanding government securities as at March 31, according to data from the government’s funding agency Australian Office of Financial Management. That compared with 75.8% in June 2012.

Australian government bonds are typically favoured by foreigners for having the highest credit rating and the extra yield they offer over other developed markets.

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