Omicron Fuels Aussie Bond Rally as It Rips Into Rate-Hike Bets

(Bloomberg) — Aggressive bets on rate hikes by Australia’s central bank are receding, driving benchmark bonds higher, as omicron cases skyrocket. 

Yields on the nation’s three-year notes slumped six basis points to a one-week low of 0.87% Wednesday, while swaps traders dialed back earlier bets for a higher policy rate in the first half of next year.

The moves underscore the difficulty investors face in positioning their portfolios into year-end, and the challenge for central bankers as economies reopen at a time when the new coronavirus variant is spreading like wildfire. New cases are setting record highs daily in Australia, though the number of patients in intensive care remains manageable for now. 

“Three-years are leading the squeeze on omicron and buy-flow,” said Kellie Wood, a fixed income fund manager at Schroders Plc in Sydney. “Thin markets are exaggerating the move.”

Just a month ago, Australians were feeling ebullient as they emerged from protracted lockdowns. Consumer spending rebounded strongly, employers went on a record hiring spree and business confidence boomed. The RBA even upgraded its forecast for economic growth to a brisk 5.5% in 2022.

Overnight index swaps were pointing to the Reserve Bank of Australia raising rates from a record low 0.1% as soon as May. Now traders are not so sure. 

OIS dated for the RBA’s June meeting fell nine basis points this week to 0.22%, set for the steepest weekly drop since the pandemic began. The first rate move is now fully-priced in for July, from June on Tuesday.

Much concern among investors focuses on the most-populous state of New South Wales and its capital Sydney, which is at the center of the surge in omicron cases. The state’s government is also the most aggressive in the nation in pressing ahead with a roll-back of mobility restrictions.  

One infections model suggests nationwide cases could jump to 200,000 a day early next year, from around 5,000 now, amid waning protection from vaccines and without the reimposition of some physical-distancing and mobility rules. 

RBA Governor Philip Lowe has said the central bank board will consider changes to its bond buying program at its February meeting, after the situation with omicron becomes more clear.

He has repeatedly pushed back against market pricing for rate hikes in 2022, emphasizing that rates should remain at record lows until actual inflation, not forecast, is within the RBA’s 2-3% target band. Lowe doesn’t expect this until late-2023.

Amid the concern and uncertainty sparked by omicron, some investors are more sanguine, holding to the view that typically thin year-end trading is to blame for recent market moves, not the virus.

“It’s likely some short-covering into year-end in low liquidity conditions,” said Robert Thompson, rates strategist at Royal Bank of Canada in Sydney. “It’s flow driving the move rather than the market in aggregate suddenly re-assessing omicron risks in Australia.”

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