Speaking at a forum in Tokyo on Thursday, the head of domestic markets at the Reserve Bank (RBA), David Jacobs, outlined two primary headwinds facing the bond market – intensifying competition for capital and the heightened potential for global market disruptions to spill over into the domestic market.
“We are facing a volatile world,” Jacobs said. “The global economic system is in flux and what will emerge is difficult to predict. 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.”
He cautioned that in an uncertain environment, “we should be prepared for periods of volatility and market disruption, as events in early April highlighted”.
Elaborating on the intensifying competition for capital, Jacobs said recent years have seen increased supply of government bonds globally – a trend he described as a fundamental shift.
This, he noted, is projected to occur in Australia too, where he tipped supply available to private investors would rise by about 4 percentage points of gross domestic product annually, driven by increased funding needs and the RBA’s balance sheet unwinding, even as foreign investors continue to hold around two-thirds of the free float.
“In this context, Australia’s institutions and credit profile have long provided an important comparative advantage. Our discussions in liaison confirm that foreign investors are attracted to Australia’s strong and stable institutional arrangements,” he said, but added that 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, he explained, may be concerned about Australia’s exposure as a small economy with a large trade relationship with China.
However, ultimately, he said, Australia’s robust institutional framework and floating exchange rate are expected to help absorb changes in investor demand.
“In some scenarios where these institutional factors take precedence, Australia could even be a net recipient of broader portfolio allocations.”
Turning to market disruptions and spillovers, Jacobs said, “in an environment of elevated uncertainty, increasing supply and leverage in global bond markets, we need to be prepared for periodic disruptions” – such as those witnessed in April.
Regarding Trump’s “Liberation Day” announcement in April, he said: “On this occasion, Australian markets were ultimately able to adjust – we saw a repricing, but not a broad-based shift to cash.”
However, he cautioned that a key reason markets stabilised quickly was the pause in tariff implementation, warning there is “little room for complacency” and pointed to key lessons, one of which is the importance of keeping a close eye on market leverage.
“We did not see large-scale deleveraging in AGS or other Australian bonds. But leveraged investors such as hedge funds have had an increased role in many markets in recent years. They bring significant benefits as a source of liquidity in normal times, but also introduce risks as deleveraging can amplify shocks,” he said.
Moreover, Jacobs highlighted that in contrast to other countries where pension funds and insurers may employ significant leverage, Australia’s superannuation sector is generally restricted from doing so, reducing systemic exposure.
“And, ultimately, this [April] was a reminder of the importance of resilience in core money markets,” he said.
“Australian repo markets continued to function, which avoided broader deleveraging and supported the ability to trade and issue in bonds. In turn, liquidity in money markets was supported by the RBA’s monetary policy implementation framework.”
