Australian bonds continue to rally after RBA leaves interest rate on hold, election uncertainty

The Australian government bonds continue to rally on Tuesday after the Reserve Bank of Australia (RBA) maintained its key interest rate at a record low of 1.75%, as expected. Also, the reserve bank opted to leave rates on hold at its July meeting, with Australia still in political limbo as the country awaits the outcome of Saturday’s inconclusive election cliffhanger.

The yield on the benchmark 10-year Treasury note, which moves inversely to its price fell 7 basis points to 1.941 percent and the yield on short-term 2-year note also dipped 1-1/2 basis points to 1.596 percent by 05:30 GMT.

The Reserve Bank has left rates on hold at their current all-time low at 1.75 percent, as the central bank waits for a crucial update on inflation due out on July 27. The RBA in its monetary policy statement mentioned that the global economy is continuing to grow, at a lower than average pace. Several advanced economies have recorded improved conditions over the past year, but conditions have become more difficult for a number of emerging market economies. China's growth rate has moderated further, though recent actions by Chinese policymakers are supporting the near-term outlook.

They further added that the financial markets have been volatile recently as investors have re-priced assets after the UK referendum. But most markets have continued to function effectively. Funding costs for high-quality borrowers remain low and, globally, monetary policy remains remarkably accommodative. Any effects of the referendum outcome on global economic activity remain to be seen and, outside the effects on the UK economy itself, may be hard to discern.

Lastly, they concluded that inflation has been quite low and given very subdued growth in labour costs and very low cost pressures elsewhere in the world, this is expected to remain the case for some time. Low interest rates have been supporting domestic demand and the lower exchange rate since 2013 is helping the traded sector. Financial institutions are in a position to lend and credit growth has been moderate. These factors are all assisting the economy to make the necessary economic adjustments, though an appreciating exchange rate could complicate this.

In the early Asian session today, the yield on 10-year hit a record low 1.935 percent, under pressure following data showing a wider-than-expected trade deficit in May and soft retail sales growth.

In terms of data, Australia May trade deficit rose to USD 2,218 million, against market expectation of –USD 1700 million, from –USD 1579 million in April. Similarly, Australia May retail sales rose marginally 0.2 percent m/m, lower than the market consensus for 0.3 percent, as compared to 0.1 percent in April, revised from 0.2 percent. Australia June services PMI edged down to 51.3, from 51.5 in May and ANZ/Roy Morgan weekly consumer sentiment survey, consumer sentiment index fell slightly to 115.8, from 116.8 in the last week.

In addition, Australian Prime Minister Malcolm Turnbull said that 3 million votes to be counted in the next few days and result shows voter discontent with major parties.

Moreover, The Australian federal election over the weekend failed to produce a clear winner, with major parities failing to gain an outright majority, raising the prospect of prolonged political uncertainty (still the outcome is too close to call). To form a majority government a party needs to win 76 seats, each of the major parties has won 67 seats so far and 5 seats have been won by minor parties or independents so far, 11 seats remain in doubt.

Interestingly, Australian election counting was done on Saturday night and then stopped for Sunday and Monday. It restarted again today, but still nothing conclusive. Around 80 percent of the vote has been counted. While the result is too close to call it does appear likely that the current ruling coalition (Liberal) will win the majority of the 11 seats still in doubt (probably 8 of the 11) - they need to win at least 9 of the 11 to form a majority government, but if it is less than 9 then they would typically get the first crack at forming a minority government. It does not appear likely that the current opposition party (Labor) can win majority government.

In addition, the S&P in a report said they may cut Australian rating if budget gridlock continues and inconclusive election result clouds the fiscal outlook. They further mentioned that an improving budget balance is important to Australia's rating and S&P outlook is based on conservative budget policies. Lower Australian rating if parliament gridlock continues, lower Australian rating if budget gridlock continues, they added.

Meanwhile, the AUD hovering between 0.7500-0.7545 range against USD, the benchmark Australia's S&P/ASX 200 index was trading down 1.15 percent, or 60 points, at 5,178.5 by 05:30 GMT.