More rate cuts tipped as mining boom fades
Bond giant Pimco says debt markets are misguided to bet the Reserve Bank is almost finished cutting interest rates, arguing that the economy will struggle to cope as a resource investment boom fades.
"The big economic uncertainty arrives when the economy transitions from an investment destination to a production and export engine," said Robert Mead, Sydney-based head of portfolio management at Pimco, which runs the world's biggest bond fund. "This transition will not be smooth."
The Reserve Bank of Australia is expected to lower the overnight cash rate target to 2.75 per cent from 3 per cent by December 31, according to the median forecast of 29 economists surveyed by Bloomberg News.
Traders expect 32 basis points of cuts over 12 months, down from 56 basis points seen on January 28, according to a Credit Suisse index based on swaps.
Investors are hoping for a clearer picture of the RBA's intentions when it releases the minutes of its February 5 board meeting today.
The central bank kept the cash rate at 3 per cent in February after cutting it by a quarter of a percentage point at its previous meeting in December.
Pimco is investing in longer-dated swaps, state government bonds and high-quality corporate notes as markets. These markets had priced in an "unrealistic series" of rate cuts, and are now probably not pricing in enough, said Mead.
The fund manager, which oversees $US2 trillion worldwide, expects the Australian economy to struggle towards the end of 2013 and early next year as growth moderates in China, the nation's largest trading partner. The RBA predicted "below trend" 2013 growth of about 2.5 per cent on February 8, slowing from 3.5 per cent last year.
Mining investment will likely peak this year, and at a lower level than previously expected, RBA assistant governor Christopher Kent said on February 15. Chinese demand for commodities will grow "strongly" for some time, but at a slower pace, he said.
"We estimate transition somewhere between fourth quarter 2013 and second quarter 2014, depending on projects being on time et cetera, so the growth uncertainty will increase over this period and the market will start to anticipate this uncertainty well in advance," Mead said in response to e-mailed questions.
The extra yield 10-year swap rates offer over similar- maturity government debt was 50 basis points yesterday, compared with a 26-basis-point gap for three-year securities, Bloomberg data show. Pimco isn't buying Australian sovereign debt, Mead said.
"The offshore bid for Australian assets was predominantly in Commonwealth government bonds, so they became relatively expensive versus other, high-quality alternatives," he said. "We are focused on the carry benefit of these assets in what we expect to be a fairly benign credit market for high-quality borrowers," Mead said with regard to swaps, state government and corporate notes.
Australian sovereign bonds fell 0.7 per cent this year, Bank of America Merrill Lynch indexes show. That is the smallest loss among the eight nations that hold a stable AAA rating from all three of Fitch Ratings, Moody's Investors Service and Standard & Poor's.
Securities issued by Australian states and territories declined 0.3 per cent, while corporate bonds have returned 0.3 per cent, according to Merrill Lynch data.
Australia's economic prospects remain dependent on mining, with the RBA yet to see significant impact from its efforts to spur household and corporate spending through 1.75 percentage points of interest-rate cuts since November 2011.
Retail sales declined in the final three months of 2012, the longest stretch in 13 years, and home-loan and building approvals fell in December. A gauge of manufacturing weakened to a three-and-half-year low in January and services contracted for a 12th month, Australian Industry Group reports showed.
Consumers remain cautious as the nation's employers reduced full-time positions for a third month in January, the longest period of cuts since 2009.
"The Australian economy continues to slow and we believe Chinese growth will also moderate into the second half of 2013," Mead said.
Australian growth will be about one percentage point slower this year, according to RBA forecasts, the biggest decline among Group of 10 currency nations after Japan. The world's third- largest economy will expand 0.9 per cent this year, compared with 1.98 per cent in 2012, while Chinese growth will quicken to 8.15 per cent from 7.8 per cent in the previous year, Bloomberg surveys show.
There are some signs that consumers are beginning to respond to lower borrowing costs. A sentiment index for February jumped 7.7 per cent to 108.3, a Westpac Banking Corporation and Melbourne Institute survey taken from February 4 to 8 of 1200 adults showed last week. That was the strongest reading since December 2010 and the fourth-straight figure above 100 that indicates optimists outnumber pessimists.
"This adds further weight to our view that the soft patch in the Australian economy may now be behind us," Paul Bloxham, chief economist for HSBC Holdings in Sydney and a former RBA official, wrote in a research report on February 13.
"We maintain our non-consensus view that the RBA's easing phase is done." Bloxham is the only economist among 29 polled by Bloomberg this month to predict a rate increase this year.
Prospects for slower growth have led analysts to predict Australia will be the only major developed economy where benchmark 10-year yields will remain little changed by the end of this year at 3.52 per cent, from 3.56 yesterday in Sydney.
Rates will climb 32 basis points for Treasuries, 25 points for bonds and 24 points for Japanese bonds, according to data compiled by Bloomberg.
The gap between Australian and US 10-year yields narrowed to 1.52 percentage points on February 15 from an almost four-month high of 1.67 on December 14. It will end the year at 1.2 percentage points, should the consensus forecasts prove accurate.
"With the mining investment cycle passing its peak, plus the elevated Australian dollar, there remains a limit in terms of how high Australian yields can go, especially given the retracement we have seen since fourth-quarter 2012," Mead said. "The starting level of real yields and the economic fundamentals will eventually lead to outperformance of Australian bonds versus other developed markets."
The Aussie dollar, the world's fifth most-traded currency, declined 1 per cent this year to $1.0293 as of 5 pm in Sydney yesterday.
The gap between rates on Australian government bonds and inflation-linked debt shows traders expect a 2.72 per cent annual advance in consumer prices over the next decade, down from a near 10-month high of 2.80 per cent reached February 4.
Governor Stevens left the nation's benchmark rate unchanged on February 5 and said the inflation outlook created room to "ease policy further". Consumer prices will rise 3 per cent in the year to June 2013, down from a previous forecast for 3.25 per cent, the central bank said on February 8. Policy makers aim for underlying average inflation of 2 to 3 per cent a year.
"The RBA has not finished their cycle, unless of course we see a significant drop in the Australian dollar or an abandonment of fiscal discipline," Mead said.
Bloomberg, with AAP