RBA steeling for bond market volatility

He said there was “little room for complacency” given the market stabilisation was due to the pause on the implementation of tariffs.

Given there is the potential for market disruptions to spill over into the Australian market, he said the RBA was “prepared for periodic disruptions”, particularly in a period of increasing supply and leverage in global bond markets.

The context: Jacobs did not water down concerns about the future but emphasised that Australian markets had shown resiliency and that the April episode did not become systemic or result in an exodus to cash.

He said the Australian bond market has key enduring strengths. This includes its growth aligning with more depth, diversity and infrastructure and, more broadly, the market being backed by stable institutions and favourable credit ratings. This is expected to ensure Australia remains attractive for international capital flows.

“Australia’s open economy has long benefited from open capital flows, and the Australian bond market provides a critical linkage with the rest of the world,” Jacobs said at the conference.

One lesson from the April tariff fall out he raised in his speech is for investors to remain attentive to market leverage, with no large-scale deleveraging in Australian government securities or bonds occurring during this recent episode. However, he noted that leveraged investors have been playing a bigger role in markets recently and in Australia he said hedge funds are a growing source of demand for sectors such as semis.

“They bring significant benefits as a source of liquidity in normal times, but also introduce risks as deleveraging can amplify shocks,” Jacobs said.

The numbers: Jacobs said the free-float of Australian government securities available to private investors is expected to rise by 4 percentage points of GDP a year in “coming years”. This is the highest since the pandemic, reflecting an unwinding of the RBA’s holdings.

“At the same time, foreign investors continue to own a large share of Australian bonds,” he said. “That is despite a rapidly growing pool of domestic savings”.

About two thirds of the free float of Australian government securities available to the private market are owned by foreign investors. Jacobs said foreign investors are attracted to low levels of general government net debt, at around 30% of GDP.

“As a result, while Australia comprises only around 1% of the outstanding sovereign bonds in advanced economies, it makes up more than 10% of the AAA-rated sovereign bond universe,” he said.

What they said: “Much as international trade may be diverted in a new economic order — so too might international capital. There are a range of plausible scenarios for how this may play out,” Jacobs said.

“Investors may be concerned about Australia’s exposures as a small economy with a large trade relationship with China and a major stake in an open international trading and financial architecture. But working in the other direction are the enduring institutional factors I have mentioned, which will continue to be attractive to investors.”

He said Australia may even be a net recipient of portfolio allocations in some scenarios.

“Ultimately, prices will clear markets. And Australia’s floating exchange rate has historically also provided important flexibility, helping to absorb any shifts in relative demand for Australian assets.”