SYDNEY--The sharp rise in Australian government bond yields to 15-year highs this year has taken a breather recently, but there's few that think the worst is over.
The 10-year government bond yield is now around 5.18%, near its lowest since early September, down from recent highs of just above 5.40%.
The recent retreat in bond yields globally has eased concerns that the bond market might have been heading toward a moment of dislocation where liquidity thins, confidence dives and yields swing erratically.
The fall in yields will have brought at least temporary relief to governments worried about soaring debt repayments, and firms seeking to fund new capital expenditure.
But the outlook for bond yields remains worrisome.
"It's just a pause I think. Australian 10-year bond yields are down from their recent highs because like their U.S. counterparts, they could be oversold and were due a relief rally," said Shane Oliver, head of investment strategy at AMP.
Still, "yields are vulnerable to a resumption of the rising trend," he added.
Bond markets will remain jittery given excessive public debt levels globally, rising corporate debt, inflation risks, and erratic policymaking in the U.S., Oliver said.
The fears stretch to Europe, with political will to curb spending in key economies such as France likely wilting due to ongoing public unrest on the streets of Paris and other major cities.
"All of this points to rising long-term bond yields globally over time and Australia will not be immune to this," Oliver added.
"Governments seem both unable and unwilling to exercise restraint on fiscal policy. The private sector is quickly becoming the new marginal buyer of government bonds, and we don't get the sense they feel adequately compensated for the risk yet," said Josh Rout, portfolio manager at Franklin Templeton in Australia.
Local traders also remain riveted to the Reserve Bank of Australia after warnings from Deputy Gov. Andrew Hauser this week that the inflation outlook has gotten "materially worse."
His remarks were just the latest from the RBA, which has been signaling for some time now that it has run out of patience with regard to elevated inflation.
Still, if the RBA does continue to raise interest rates aggressively, fears about a recession next year will also grow. A contracting economy will at least slow the rise in bond yields.
The central bank faces "difficult choices," Hauser said.
Jack Chambers, rates strategist at ANZ, said the pause in bond yields is also linked to doubts about the sustainability of the artificial-intelligence investment boom.
"We've generally seen a drop in long-end yields. This is partly a risk story, with some questioning the AI trade, which has driven some of the rally in long-end yields," he said.
The upward trend in yields is set to resume, Chambers said.
"We expect the RBA and Federal Reserve to both hike at their next meetings and it seems pre-emptive to call time on the AI trade," he added.
If growth cools sharply next year, bond yields may reverse course.
Franklin Templeton's Rout said the forward radar of bond traders is now on next year when the Australian economy is expected to have slowed due to high interest rates and a correction in the housing market.
"It feels as though the market is now prepared to look far enough ahead to see the headwinds to growth," he said.
Calls to sharply cut immigration would also see a key engine of economic growth power down, he added.
With threats to growth rising, the RBA will be very cautious raising rates further from here, Rout said.
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