Bond rout spells end of low rates

A global rout in bonds could spell the end of a 34-year fall in Australia’s long-term borrowing rates to record lows.

Rising bond yields could have negative implications for asset prices, including Australian ­property. Picture: Richard Walker

A global rout in bonds that has wiped $US1.6 trillion ($2.1 trillion) in value from the market following the election of Donald Trump could spell the end of a 34-year fall in Australia’s long-term borrowing rates after they hit record lows this year.

Amid potential for higher US inflation and economic growth stemming from Mr Trump’s plans to loosen fiscal policy and slap tariffs on China, benchmark Australian 10-year bond yields soared to 2.74 per cent — the highest level since January — as equivalent US Treasury yields surged to 2.3 per cent as the post-US election sell-off continued. Bond yields rise as prices fall.

The “bondcano” that has wiped about $US1.6 trillion off the global bond market in the past week alone has also shaved an ­estimated $17 billion of value from the Australian fixed-income ­market.

“We’re recalibrating to a new regime,” said Adam Donaldson, head of fixed income and interest rates strategy at Commonwealth Bank. “Trump’s election means we are in a new cycle whereby the continued downward moves in yields and rates have come to an end.”

Rising bond yields could have negative implications for asset prices, including Australian ­property.

While several economists still expected the Reserve Bank to cut the official cash rate to a new record low next year, the market-implied chance of a cut fell to 14 per cent, versus 35 per cent a week ago. The dollar struck a four-week low of US75.2c this week.

After bouncing off a record low of 1.82 per cent in early August, Australian 10-year bond yields closed little changed at 2.658 per cent as US Treasury yields eased to 2.2 per cent after a spectacular 34 per cent rise from a low of 1.71 per cent in the past three days.

Australia’s benchmark S&P/ASX 200 share index has surged more than 3 per cent since the US election, but the dramatic sell-off in bonds has hurt defensive yield or “bond proxies” in the Australian sharemarket that were until recently favoured for their attractive dividend yields and stable cash flows as central banks slashed interest rates in the wake of the global financial crisis.

Telstra, Westfield, Scentre Group, Westfield, Sydney Airport and APA Group shares are down about 20 per cent since the bond rout began in August, sharply underperforming the S&P/ASX 200.

“We’ve been looking for some sort of break in what’s been relatively vicious for global markets and the global economy and we think the election of Donald Trump, if he can carry through with at least the bulk of his policies, may represent that break that we need to see,” Mr Donaldson said.

While expecting global yields to be somewhat anchored by sustained quantitative easing, negative interest rate policies and economic problems in Japan and Europe, Mr Donaldson said there were reasons to expect further upward pressure on bond yields next year, even though Mr Trump’s appointments and policies were yet to be finalised.

“Investors who have been long of bonds have endured a lot of pain and they are going to be reluctant to step back in very quickly, so that suggests yields could keep moving upward,” he said. “A lot of damage has been done to the psychology of investors who were buying bonds on low or negative yields. It’s going to be a slow process of the market finding its feet.”

Importantly, Mr Donaldson now feels that Mr Trump’s agenda means offshore influences will not necessarily stop yields rising further. He also feels that US dollar strength stemming from higher bond yields will be less of a constraint on bond yields than it was in the past. “The big constraint on bonds selling off in the past was that when that occurred you started to see wobbles in the equity market very quickly,” he said.

“You don’t have that this time around because the US is planning to cut corporate tax rates and increase infrastructure spending. Of course, there’s obviously the risk that people are getting carried away with the idea of a Trump stimulus and if that turns out to be much weaker than is being priced in, you could see bond yields and equities fall back in line.”

However, the bond market is not facing the kind of rout it saw in 1994, when the US Federal Reserve launched a series of aggressive interest rate rises to clamp down on inflation expectations.

“We think the Fed will hike interest rates relatively slowly, but bond yields move up another 50 basis points as evidence of inflation begins to emerge,” Mr Don­aldson said. “We don’t expect a full reversion to ‘normal’ given ongoing easy policy and economic problems in Europe and Japan, but we do think that the Trump agenda makes these less binding and that, in particular, the equity market will be less at risk from US dollar strength and higher yields than we previously expected.”

Goldman Sachs warned last week that the president-elect’s plans, including new restrictions on foreign trade and immigration, could have negative implications for growth over the longer term.