Doubts about the appeal of US Treasuries have prompted investors to turn to higher-rated alternative bonds, boosting the prices of bonds in Australia and Singapore.
Strategists and portfolio managers are rethinking whether US Treasuries offer sufficient returns, a rare challenge for the world’s largest bond market, especially after recent downgrades and concerns that proposed tax bills could hit foreign investors. Taiwanese insurers are planning to withdraw from dollar assets, while Hong Kong pension funds have been told to draw up contingency plans in case of further US downgrades.
Kelly Wood, head of fixed income at Schroders in Sydney, said: “A lot of fiscal risks are not yet reflected in the pricing of US bonds – downgrades, fiscal stimulus packages, investors no longer lending to the US government, etc. The possibility of fiscal missteps is rising.”
This further enhances the appeal of the world’s dwindling supply of AAA-rated bonds. The spread between 30-year Australian bonds and their US counterparts of the same maturity has approached its lowest level in a year, indicating that investors are pouring more money into Australian bonds. The spread between Singapore and US bonds of the same maturity is close to a record discount.
The yield on Australia’s 10-year government bonds dropped 11 basis points on Friday and fell slightly on Monday. The market is betting that the Reserve Bank of Australia will cut interest rates further, which has also stimulated demand for these bonds. The Reserve Bank of Australia has hinted that it will further ease policy to mitigate the impact of global economic turmoil.
For many years, insurance companies from Taiwan and Japan as well as pension funds from Australia have flocked to the US bond market, apparently in search of safe long-term assets. But recent market volatility and ongoing doubts about the US fiscal situation have forced a rethinking.
Moody’s downgraded the US rating in mid-May, becoming the last of the three major credit rating agencies to lower its top rating, and warned that the country’s fiscal deficit, government debt and interest burden would all rise in the coming years. This is just the latest sign of growing concerns over Washington’s fiscal situation.
Ding Yifei, senior fixed income portfolio manager at Invesco in Hong Kong, said that after the downgrade, some institutional investors will look for alternatives and added that AAA bonds in the Asia-Pacific region will be one of the winners.
The sharp fall of the US dollar has also put pressure on investors across Asia to seek alternative currencies. Last month, the New Taiwan dollar soared against the US dollar, raising concerns about the damage it could cause to Taiwan’s $120 billion life insurance industry. Regulatory authorities have taken steps to soothe market sentiment and are currently considering easing the asset declaration rules for insurance companies to mitigate the impact of the dollar’s depreciation.
According to a fund manager at a large Taiwanese insurance company, the company has started to build small positions in high-rated corporate bonds in Australia and the UK to diversify its dollar-denominated assets. The manager, who was not authorized to discuss investment decisions, declined to be named.
Goldman Sachs said that given the Singapore dollar market is the only AAA-rated market in Asia, reserve management institutions may gradually shift towards the Singapore dollar market. Meanwhile, Bank of America said that foreign investors in the Australian government bond market will face competition from local pension funds, whose demand for Australian dollar bonds may exceed the issuance volume.
