RBA's unreliable forecasts have bond investors thinking twice

BOND investors are demanding a premium to hold Australia's sovereign debt after being burned by the central bank's failure to provide reliable guidance on inflation and interest rates.

Strategists and analysts spoken to by Bloomberg said offshore clients have been among the worst affected and responded by shunning Australian bonds, slashing positions or moving into shorter tenors.

"The market's confidence in the Reserve Bank of Australia's messaging has definitely taken a hit," said Prashant Newnaha, a Singapore-based rates strategist at TD Securities. "Significant losses from market participants and lack of credibility in guidance have led investors to make a conscious decision to move to the sidelines."

While many of its peers were hiking rates, the RBA kept its tone dovish and borrowing costs at a record low until May, when it increased its benchmark by more than expected. Governor Philip Lowe conceded the bank's forecasting had been "embarrassing", adding to the reputational damage done by its "disorderly" exit from yield control last year.

The lack of trust from investors is reflected in Australia's 10-year bonds, which last month saw yields spike to 92 basis points above similar-dated Treasuries last month, the widest gap since January 2015.

Even after dropping back to 44 basis points on Monday (Jul 11), the difference has more than doubled this year, despite slower Australian inflation than in the US.

Su-Lin Ong, chief economist and head of fixed-income strategy at Royal Bank of Canada in Sydney, spoke to investors on a tour recently in South-east Asia, where some complained about being blindsided by the RBA.

The response of many has been to opt for "vanilla-type positions" that are easiest to hedge, she said.

The RBA is under intense scrutiny again this month as investors await Australia's second-quarter inflation report. Consumer price data for the first 3 months of 2022 played a big part in policymakers tightening in May, much earlier than their previous guidance.

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RBA raises interest rates in quickest tightening on record

The RBA has now increased its benchmark by 125 basis points to 1.35 per cent while the Federal Reserve has raised the upper bound of its target to 1.75 per cent in a more aggressive cycle that would normally help narrow the gap on bond yields between the 2 nations.

But it is the credibility gap that is driving the divergence in yields.

Overnight indexed swaps imply the RBA's cash rate will reach 3.6 per cent by February, compared with around 2.6 per cent predicted by economists. By contrast, swaps traders, economists and the Federal Reserve are largely aligned on the outlook for the benchmark rate in the US. BLOOMBERG