Bond yields to remain range-bound

Australian bond yields are expected to remain range-bound and will continue to provide strong diversification and defensive characteristics for investors’ portfolios despite tightening credit conditions, a slowing housing market and deteriorating mortgage serviceability metrics, according to PIMCO.

However, all these factors would curb household consumption, the firm said.

Additionally, out-of-cycle mortgage rate increases by the banks would keep the Reserve Bank of Australia (RBA) on hold for longer while the new neutral rate in Australia was low, around three per cent compared with the RBA’s estimate of 3.5 per cent.

“We therefore remain neutral on Australian duration with a curve steepening bias. In our view, the likelihood of further funding pressure on the banking system will keep an asymmetric bias to the downside for the Australian dollar,” PIMCO said in a note.

The firm also warned its view on the Australian banks was more cautious as mortgages represented two-thirds of bank lending, so changes in the housing market would directly affect the credit profiles of the banks.

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“The probability of a market-moving agency downgrade that causes major banks to lose their AA-rating for the first time in history is now higher than before,” PIMCO said.

“A downgrade can be triggered by weaker perceived institutional strength of the country’s banking sector, reduced sovereign support or deteriorating loan performance in a more-severe-than-expected downturn scenario.”

At the same time, potential market dislocations might help create value opportunities for active investors with deep knowledge of the market.