ALERT: International bond markets

Alarm over bond yield fall

THE collapse in yields on bonds sold by so-called safe countries such as Australia, Germany and the US in recent days has put investors on edge due to fears the global economy is again entering the danger zone of the financial crisis.

SMH,

2 June, 2012

The rapid falls have delivered the strongest message yet from the market to the Reserve Bank of Australia to make a decisive cut to interest rates when its board meets to discuss cash rates on Tuesday.

Australian government borrowing costs continued to push record lows yesterday as investors piled in amid concerns Europe's problems have hit a tipping point.

Traders interpreted the falls on bond markets as saying there is a high chance of global contagion from the sovereign debt and banking pressures in Europe. German and US bonds, countries that also have a AAA credit rating, also fell to fresh lows.

''It's an astonishing move,'' said George Boubouras, the head of investment strategy and consulting at UBS, of the bond market moves.

''The bond market is telling us that cash rates must come down and cash rates must come down quicker than the RBA are comfortable with.''

Bonds are often viewed as an indicator of the direction of equity markets. When equity markets are healthy, yields on lower risk bonds are high, but this is reversed in times of volatility as investors look for somewhere safe to park their money.

For most of the past decade bond markets flew under the radar while equity markets were booming. But a collapse in yields in early 2008 foreshadowed a shock to global equity markets.

Interest rate futures now point to an even-money bet that the RBA will match May's 50 basis point cut and reduce its cash rate to 3.25 per cent - leaving it not far off the lows during the global financial crisis.

However, most economists believe the RBA will take a more cautious approach and push through a series of 25 basis point cuts over a period of months.

The chief economist at Commonwealth Bank, Michael Blythe, believes the RBA will hold its nerve with softer cuts.

''We are reluctant to endorse the aggressive rate cut profile evident in market pricing due to the need for a central bank to be prudent and retain the ability for a more aggressive rate response if something really does go wrong offshore,'' he said.

The yield on Australia's 10-year note was yesterday trading at 2.85 per cent.

US Treasury 10-year yields dropped to a low of 1.53 per cent yesterday, while similar-maturity German bunds touched a record level of 1.199 per cent.