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We noted a while back that Australia was facing a serious problem in its bond markets. In short, the country seems to be running out of public government debt.
There isn’t anywhere near enough to satisfy demand. The pressure is heightened by regulatory demands for Australian banks to hold ever more of their capital in liquid government debt securities.
The situation has even led some central bank types to come up with creative ways to manufacture alternative forms of quality collateral.
This chart from Anthony Doyle at Bond Vigilantes perhaps really highlights the problem best:
Much of the crowding out of the Australian bond market is down to hot money inflows from abroad. Foreign ownership of Australian government bonds now stands at 80.4 per cent of the market – a record amount.
As Doyle notes:
For us, this is worrying as heavy foreign ownership of government bonds can be very dangerous, particularly when this is combined with a country running a current account deficit (i.e. the country is reliant on capital inflows from abroad). Ireland and Portugal, which saw similar levels of foreign ownership before the crisis hit, are great (or poor?) examples of how this combination can leave a country's exchange rate and solvency very exposed if the country hits a crisis.
That said, Australia is obviously not Ireland. As Doyle notes, it has the ability to print its own currency and to set its own interest rates. Also, Australia’s current account deficit is only 1.5 per cent of GDP, which is far from alarming.
Though, if its safe haven AAA status was ever to be questioned — say, because of exposure to a Chinese downturn — things could change pretty quickly.
As Doyle concludes, the scale of the potential capital outflows from the bond markets could leave the Aussie dollar especially vulnerable.
Related links: Bias in bonds - FT Alphaville The German bond market is all about "?buy and hold' - FT Alphaville Manufacturing quality collateral – FT Alphaville
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