Tags: Pimco | Bets | Australian | rate

Pimco Bets on Australian Interest-rate Cut

Sunday, 25 August 2013 11:21 AM

Pacific Investment Management Co. is buying Australian debt, predicting the central bank will surprise markets by cutting rates another half a percentage point to combat currency strength.

The Reserve Bank of Australia may drop its benchmark to 2 percent by early next year from a record-low 2.5 percent, according to Pimco, which runs the world’s biggest bond fund. The Aussie dollar is 19 percent above its post-float average, indicating it may extend its 15 percent drop since April and fall toward 80 cents, the fund manager said.

“The currency is not weakening as much as they had hoped and that probably calls for more rate cuts,” Scott Mather, head of global portfolio management for Newport Beach, California- based Pimco, said in an interview on Aug. 23 from Auckland. “There’s a chance for more rapid capital gains going forward if we’re right about the rate outlook.”

Pimco’s view is at odds with other investors, who are pricing in just a 16 percent chance the RBA benchmark will be 2 percent or lower by the end of March, according to Bloomberg- compiled swaps data. While Australian government notes are heading for their steepest monthly loss in more than four years, their 78 percent return over the past decade is the best after New Zealand among developed markets, Bank of America Merrill Lynch indexes show.

Buying More

Mather said Pimco is holding more Aussie debt than the benchmarks it tracks and has added to those holdings recently. Its investments include swaps, highly-rated state government and Kangaroo bonds and federal government securities.

Notes issued by the Australian government delivered a 1.4 percent loss from the end of July through Aug. 22, which would be their worst monthly performance since May 2009, a Bank of America Merrill Lynch index shows.

The yield on the benchmark 10-year security has climbed 32 basis points this month to 4.05 percent. The spread over similar-maturity Treasuries was 116 basis points, having narrowed from 152 basis points at the end of 2012.

The U.S. rate last week touched a two-year high as investors bet that a possible unwinding of Federal Reserve stimulus measures would undermine the value of the notes.

Yields Overdone

The climb in longer-term yields has been overdone in the U.S. and Australia, Mather said.

Pimco favors “strategies to take advantage of the steepness of the curve both in the U.S. and elsewhere in the world, particularly in places like Europe and in Australia, where they’ve been dragged along with the U.S. for no good reason,” said Mather. “In addition to the stated yield, you get a lot of roll down and capital gains from just holding bonds that are rolling down the yield curve.”

As a bond nears maturity or rolls down the yield curve, it is valued at successively lower yields and higher prices.

The prospect that the Fed will taper its asset purchase program has added to downward pressure on the Australian currency, which traded at 89.99 U.S. cents as of 5 p.m. in Sydney on Aug. 23, down from $1.0582 on April 11.

“A year from now it could easily be closer to 80 than it is to 90” U.S. cents, according to Mather. “The Australian dollar should be pretty volatile, but we think it will trend lower over the next year.”

Australia’s real effective exchange rate remains overvalued by 5 percent to 15 percent, the International Monetary Fund said in a report published Aug. 1.

Further Cuts

The RBA said the currency’s direction will be important in setting policy and signaled it may add to 2.25 percentage points of rate cuts made since late 2011, in the minutes of the Aug. 6 meeting at which it lowered borrowing costs.

“Regarding the communication of this decision, members agreed that the bank should neither close off the possibility of reducing rates further, nor signal an imminent intention to reduce rates further,” the central bank said in minutes of the meeting released on Aug. 20. “The course of the exchange rate would be important.”

Part of the reason that the Aussie dollar has remained stronger than the RBA would like is the fact that Australia is one of a dwindling number of nations to hold top credit scores from the world’s major ratings companies and this provides a boost to the attractiveness of the country’s debt, according to Mather. The divergence of RBA policy from the global rise in interest rates has also added to the appeal of Aussie bonds, he said.

“The central bank has to cut rates further than they otherwise would have to,” said Mather. “We think it’s possible by end of this year, beginning of next year we’re at that 2 percent level.”

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Pacific Investment Management Co. is buying Australian debt, predicting the central bank will surprise markets by cutting rates another half a percentage point to combat currency strength.
Sunday, 25 August 2013 11:21 AM
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