With increasing talk of the end of quantitative easing (QE) in the US, bond market experts predict rising real bond yields in the US. This is likely to boost the appeal of local bonds versus their US counterparts, they said.
The expectation is that US Fed will end its QE program in June and possibly raise rates in December this year. While Australian bond yields have already risen with official rate rises, yields are expected to rise on Treasuries as the US economy recovers.
"We think the Fed will stick to its QE program and it will stop buying Treasuries in June," Commonwealth Bank head of debt research Adam Donaldson said.
"We think the US economy is well enough that they can safely end the program. We think financial markets will adjust to that and the US Fed could then raise rates late in December as the US economy continues to recover," Donaldson said.
In August 2010 the US Federal Reserve decided to renew quantitative easing because the US economy was not growing enough. In November, the US Fed announced it would increase quantitative easing, buying $US600 billion of Treasuries by the end of June this year.
"With the end of QE . a key view we express to clients is that real US bond yields will rise and so one of our recommendations is to buy 2020 Australian inflation-indexed bonds versus (2020) linkers in the US. We expect the margin on those to narrow sharply from the second half of this year," Donaldson said.
The spread on those bonds is currently around 180 basis points, with the spread expected to narrow to as low as 110 basis points by the year's end.
"We're also suggesting for additional pick-up NSW TCorp Nov 2020 inflation-linked bonds which are yielding 45 basis points above Commonwealth linked-bonds."
Donaldson said he expects the local yield curve to flatten markedly by the year's end, with the spread between 2018 and 2012 bonds expected to narrow to 10 basis points, down from a current level of around 53 basis points.
The flattening will result as the Reserve Bank raises official rates to counter inflation. The CBA forecasts a rate rise in August and three more after that, with the cash rate rising to 5.75 per cent by mid 2012.
"We're recommending to clients that the buy 2018 bonds versus 2012 bonds as we expect the yield curve to flatten from June," Donaldson said.
Kapstream managing director Nick Maroutsos also expects quantitative easing to end in the US after June, with the US Fed possibly raising rates next year. That should see local bonds outperform.
"One of the trades that we like on a long-term macro basis is being short US 10-year bonds and being long Australian 10-year bonds," he said.
"The RBA is well ahead of the curve and they are near the end of the rate-rise cycle. We expect Australian 10-year bonds to outperform Treasuries as the Aussie market has already sold off. We expect the spread to narrow from around its current level of 220 basis points to between 50 and 75 basis points. The narrowing will start to happen well ahead of the Fed raising rates," he said.
"On top of that, yields being offered are exceptionally good, in the 5 per cent to 6 per cent range, which will attract investors," Maroutsos said.
