“Strong bouts” of volatility will continue to be a feature of the Australian and international bond markets for the foreseeable future, with the potential for market dislocation, the chief executive of the Australian Office of Financial Management has warned.
AOFM CEO Rob Nicholl said: “After nearly 10 years of significant central bank asset purchases and the financial market behaviours that have been built around that, it is hard to imagine that unwinding this, even partially, will not involve significant relative asset price readjustment on a broad scale.
“In fact, we have already seen this underway with purpose. How far it goes and for how long it continues is difficult to forecast but what is likely is that it will continue to be associated with strong bouts of market volatility.”
Speaking at an Australian Business Economists event in Sydney yesterday, Nicholl said the contributors to that volatility include the risk of heightened and prolonged inflation, the difficulty of fiscal forecasting and the frequency of revisions to the issuance task, and the impact of changes to monetary policy and central bank bond buying.
“Nominal bonds become less attractive during outbreaks of persistent inflation but offsetting this could well be that bonds generally will play a greater role in portfolios if economic recessions emerge.
“There is no general outlook for slowing sovereign issuance globally, so this is likely to exacerbate the quantitative tightening effect.
“Deteriorating market liquidity, which has been happening broadly, creates the ongoing potential for high volatility to induce short periods of market dislocation. While not a concern for us getting programs funded, it does present the possibility of periods where issuance choices are more constrained than usual.”
On the positive side, Nicholl said the official money part of the investor base has broadened, with some major new institutions having entered the AGS market.
“In any case, the domestic bank balance sheets are also expected to again become a dominant part of the AGS investor base as they need to rebuild bond holdings to adjust high-quality liquid asset compositions over the next few years,” he said.
As to issuance activity, Nicholl said decisions around bond lines are made with the aim of facilitating efficient market operations.
“To this end, supporting the three and 10-year futures contract through establishing new maturities and ensuring large liquid bond lines for the underlying futures baskets has been an obvious priority. In the Australian government securities market demand for bonds underlying the three and 10-year futures baskets remain the predominant points of consistent demand.
“But we are also seeing the 30-year point on the curve become a distinct point of interest. Regular replacement of the 30-year benchmark bond will be important.”