Australia's 10-year yields have collapsed to 60-year lows as fears about European growth and debt levels drive investors to the safety of government bonds, with some experts tipping yields to fall below 3 per cent this year.
Further cuts in interest rates and high demand for Australian bonds from foreign central banks and offshore funds will push down yields, according to Nomura interest-rate strategist Martin Whetton.
The yield on the benchmark 10-year bond fell to 3.15 per cent on Wednesday, a fresh 60-year low - down from around 4 per cent in January.
"We believe that yields can fall further as the economy slows and the Reserve Bank of Australia (RBA) in all likelihood cuts policy rates again," said Sydney-based Whetton.
"We've seen rates fall a bit more as the Greek impasse continues. As that remains a huge factor in market thinking, we will see moves [in yields] based around the headlines."
"If we see a significant shock from Europe then 10-year bond yields will fall below 3 per cent," he said.
The spread to US Treasuries is expected to compress to 120 basis points from the current 140, having collapsed from a high of 215 in March.
Investors around the globe have this week sold off riskier assets, such as equities, after Greece's political parties failed to form a coalition government last weekend.
European shares have hit 2012 lows, with Greece expected to hold new elections next month - adding to fears it could leave the eurozone or default on its debt.
Along with lower official interest rates, the global economic uncertainty is expected to keep longer-term downward pressure on yields.
Whetton expects the RBA to cut interest rates 75 basis points by the year's end, with a 50 basis-point cut likely in July.
"Based on our interpretation of the RBA Statement on Monetary Policy and the minutes from the May meeting, we believe the RBA will deliver a 50 basis-point cut to the official cash rate in July," he said.
The economic stability of Australia versus Europe and the US has driven foreign investors to Australian bonds, also pushing yields down.
"Our long-term view is that Australian government bond yields will fall further."
We have written extensively on the high level of foreign holdings of Australian government bonds, and the exclusivity of the diminished AAA club of borrowers," Whetton said.
Foreign bond ownership is now near a new high of around 80 per cent (using the face value of the outstanding stock of bonds, as opposed to the market value which is higher), he said.
The high quality and scarcity of Australia's government bond market was underlined last week with the Australian Office of Financial Management's issuance profile for the financial year 2012-13.
"The coming year sees a notable fall-off in borrowing requirements at $9 billion."
The federal government's aim to deliver the budget to surplus of $1.5 billion in 2012-13 (ending four years of deficits ) will also reduce the supply of government bonds, he said.
