Rate-Hike Bets Are Too Much in Australia, Bond Fund Janus Says

(Bloomberg) -- Australian rates traders are pricing for a smooth central-bank exit from easy monetary policy, opening up opportunities for those who think there'll be a few hiccups along the way.

Money markets are betting the Reserve Bank of Australia will hike in June and take its benchmark policy rate to 2% from 0.1% within two years. That's much more aggressive than the RBA's wait-and-see outlook and bond investor Jay Sivapalan doubts the economy will be able to cope with such a rapid move.

“Markets are currently priced for a perfect exit from pandemic-era easing,” said Sivapalan, who heads the Janus Henderson Australian fixed interest team that manages more than A$19.2 billion ($13.7 billion). “The potential is there that the economic recovery could be much slower than that, which would then prompt the RBA to take an easier stance than expected.”

Australian bonds fell to their worst annual loss since 1994 last year as investors ramped up bets the central bank will hike early and often to tackle inflation, even as policymakers insisted they would be patient. The disconnect makes bonds maturing in two to four years look attractive, said Sivapalan.

While he expects the RBA will need to raise interest rates probably in November, his longer-term outlook is where his view diverges most from what money markets are pricing in.

Wild Swings

“We expect the first percentage point of moves to come fast, but then a pause would be prudent for RBA to check the impact,” he said in an interview. “The market has gone further to price in going from easy to neutral to tight.”

RBA Seen Hiking as Early as June as Dovish Message Falls Flat

Three-year yields swung wildly around the 1.35% level this week as investors digested comments from RBA Governor Philip Lowe where he acknowledged a 2022 hike as ‘plausible' but stressed no need to rush. They have been no stranger to volatility since October last year, when a 90 basis point surge from the 0.3% level saw the RBA abandon its yield curve-control policy.

Markets are bracing for a fresh round of tension between traders and central bankers on Friday, when the RBA delivers its quarterly Monetary Policy Statement.

Sivapalan also sees the potential for benchmark Australian 10-year yields -- which traded around 1.87% Thursday -- to fall back below equivalent Treasuries at 1.77%, given U.S. inflation is so much stronger.

Mortgage Explosion

The huge explosion in mortgages over the past two years means that RBA hikes will have more impact than before, adding to the reasons for the central bank to move cautiously, according to Sivapalan. The value of Australian home loans has topped annual GDP for the first time.

“A 200 basis point increase in the cash rate would effectively take us back to the settings of 10 to 15 years ago,” he said. “So the RBA would need to see much more than one or two quarters of strong or extraordinary strong wages growth, it would need two to three years of such growth.”