Australian 10 year government bonds yields have fallen quite a bit in recent times, accelerating a slide that started in April of this year. As bonds are a favoured means of overseas investors participating in the Carry Trade, where they borrow money in low interest rate areas and lend to out in those where rates are higher – and who better to lend it to than the Aussie government – the reduction in yield is bad news for the currency.
As this comes on top of a mighty fall in Iron Ore prices, a staple of Australian exports, a softening of Australian employment figures and a perception of slowdown in China, one of Australian major trading partners, and further “jawboning” by the Australian central bank on the need for a lower exchange rate, we can expect more losses in the Aussie dollar.
It is the US Treasury rate differential that matters
The chart above shows US 10 year Treasury bonds. As can be seen, they have also been falling but, crucially, not at as fast a rate as the equivalent Australian security. And it is the comparison between these two that makes the essential difference in the importance of the Australian reduction in yield.
Strong as Australia is, being one of the few nations on earth to enjoy triple-A status on its debt (apart from the state of Queensland, a big producer of Iron Ore), the USA is still the measure of the risk-free rate. And there is a limit to the differential, which is still a positive figure, between the US bond yield and that of Australia at which investors will simply cease to purchase the Aussie bonds. Call it the risk premium.
As the differential falls all it will require then is a reduction, or even the rumour of one to come, in the Australian core interest rate to send the Aussie dollar through the floor.