Foreign debt crises strike fear into Oz bond market

The Australian dollar rose 0.7 per cent to US$1.0424 yesterday. Photo / Dean Purcell

Volatility in Australia's bond market is at a record high as the Europe and United States debt crises threaten the global economy.

The difference between daily high and low prices on three-year government bond futures exceeded 19 basis points for a 10th straight trading day, the first time that has happened since Bloomberg began compiling the data in 1989.

The daily fluctuation for 10-year contracts exceeded 32 basis points twice this month, a swing seen on 10 days since 2000, the data show.

Corporate bond risk surged the most in more than a year on August 11, a day after posting its biggest drop since June 2010, according to CMA.

"We've seen fundamentals and associated valuations get swamped by fear, uncertainty and illiquidity," said Damien McColough, head of fixed-income research in Sydney at Westpac Banking, Australia's second-largest lender.

"If you made money in the morning and held the position you've lost it in the afternoon and that contributes to smaller positions, less risk on board, high uncertainty and a general morale in financial markets that is very, very low right now."

The value of the global bond market has increased by US$295 billion ($352 billion) this month while more than US$5 trillion has been wiped off equity markets as Standard & Poor's downgraded US debt for the first time, riots swept across Britain and Europe's budget crisis deepened.

While Australia's central bank considered lifting borrowing costs on August 2 to control inflation, traders are betting on more than one percentage point of rate cuts by year-end, cash-rate futures show.

Three-year bond futures for September delivery fell nine basis points to 96.13 as of 11.09am yesterday local time on the Sydney Futures exchange, after rising as high as 96.30 and touching as low as 96.09. The contracts fell 10 basis points in the week ended August 12, after climbing by 71 the previous week.

Ten-year contracts fell 6.5 basis points, paring some of their 37.5 basis-point surge over the past two weeks.

Bond investors bet last month that Australia's central bank would keep rates at the highest of any developed economy after statistics bureau data on July 27 showed inflation was faster than economists forecast. Consumer prices rose at an annual pace of 3.6 per cent, the most since 2008, the data showed.

Since then, S&P lowered the US Government's credit rating to AA+ from AAA and the European Central Bank was forced to buy Spanish and Italian government debt to stem a bond-market rout. Australian cash-rate futures, which showed a 94 per cent chance on July 28 that the RBA would keep its benchmark unchanged for the rest of the year, now indicate the central bank will reduce borrowing costs by at least 100 basis points from 4.75 per cent. The rally in Australian government bonds over the past month hasn't matched the jump in Treasuries, as investors sought the safety of the world's deepest debt market.

The extra yield Australian 10-year notes offer over similar-maturity Treasuries was 223 basis points yesterday after widening to this year's high of 248 on August 10. The Australian 10-year yield rose seven basis points to 4.50 per cent, rising from the lowest level since April 2009.

The Australian dollar also swung between gains and losses last week, with three-month implied volatility jumping to a 13-month high of 17.43 on August 9, when the currency dropped below parity with the greenback for the first time since March 21. The aussie rose 0.7 per cent to US$1.0424 yesterday.

- BLOOMBERG