Unraveling the Outlook: Bond Yields and the Australian Dollar Amidst Volatility

Outlook for bond yields and the AUD

It has been a volatile 12 months for the Australian dollar, which dropped as low as 0.617 intraday against the US dollar in September 2022 and reached as high as 0.716 in February this year. Currently, the AUD is sitting in the upper half of this range. Further volatility is probable. The combination of a turn in global central bank rates, a pick-up in risk sentiment, and China’s reopening, all point to a stronger AUD in the medium term.

Still, the long-awaited weakening of the USD is proving very elusive. Global risk sentiment, as proxied by the Nasdaq, which is up more than 25% year-to-date hardly needs any further encouragement and may be due a re-think if analysts’ earnings forecasts finally start to price in recession. And China’s reopening story may prove to be a case of the dog that didn’t bark. That makes the argument for further volatility seem a stronger one than our directional preference.

 

 

We feel on stronger ground on bond yields. Australian government Treasury yields track US Treasuries closely, so the broad direction is likely to be driven by those, with local factors (RBA policy, Australian inflation etc) of second-order importance though still useful for considering the direction of spreads.

And right now, with US Treasury yields up at around 3.80%, the balance of risks for lower bond yields certainly feels better than it does for higher yields. The current spread of Australian government bond yields over US Treasuries is about 20bp, and this could widen as we think the US inflation story will improve quicker than that in Australia, resulting in a more rapid return to easing in the US.    

 

Summary forecast table

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