Worst bond blood bath since 1994

Christopher Joye

Coolabah Capital

In the AFR today I write that it is one of the worst bloodbaths “long duration” bond lovers have endured since the great crash of 1994, ramming home the interest rate risks that have been lurking behind these investments for years (click on that link to read). Excerpt only:

A massive jump in 10-year Australian interest rates, which have more than doubled since November, has hammered the price of fixed-rate, as opposed to floating-rate, bonds.

On a rolling 90 trading day basis, the fixed-rate AusBond Composite Bond Index has lost over 3.7 per cent (with more to come) in the past three months alone, and is off over 4 per cent since its early-November peak.

This should be distinguished from the zero duration AusBond Floating-Rate Note Index, which is up 0.04 per cent, not down, in the month of February. (Duration is a measure of an investment’s sensitivity to interest rate changes.) The FRN Index is also up 0.23 per cent since the Composite Bond Index started plummeting in November.

The massive leap in interest rates undeniably creates challenges for the Reserve Bank of Australia, which had been hoping to keep our risk-free rates low for long, especially vis-a-vis rate changes around the rest of the world.

The worry is that 10-year Australian government bond yields have been climbing faster than interest rates across other developed countries, which is putting further upward pressure on the Aussie dollar. On Thursday night it pierced US80¢ for the first time since February 2018.

This is being powered by a striking increase in the differential, or spread, between Australian and US 10-year government bond yields and buoyant iron ore prices.

When the RBA first started publicly discussing the possibility of buying long-term government bonds to put downward pressure on interest rates and our exchange rate, Australian 10-year government bond yields were about 20 basis points (or 0.2 percentage points) higher than US government 10-year yields.

The RBA’s initial $100 billion quantitative easing (QE) program launched last November (coupled with its commitment to a second $100 billion round after this expires in April) had kept the differential at close to zero basis points through to mid-February.

And yet as global interest rates have started normalising on the back of the rollout of effective vaccines and the prospects for better global growth (and inflation) in the year ahead, Aussie interest rates have raced ahead of peers overseas. (We’ve been very bullish on local and global growth since the pandemic hit.)

This has resulted in the yield differential between Australian and US government bonds rising to 40 basis points on Thursday night, in what some have superficially, and incorrectly, claimed negates the benefits of the RBA’s first round of QE.

Read the full column at the AFR here.

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Christopher Joye
Portfolio Manager & Chief Investment Officer
Coolabah Capital

Chris co-founded Coolabah in 2011, which today runs $7 billion with a team of 33 executives focussed on generating credit alpha from mispricings across fixed-income markets. In 2019, Chris was selected as one of FE fundinfo’s Top 10 “Alpha...

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