Australia, NZ dollars play defence as bond yields fall further

SYDNEY: The Australian and New Zealand dollars were testing support on Thursday as sharp falls in bond yields undermined their rate advantage ahead of US inflation data that just might lift the US dollar out of its recent range.

The Aussie was pinned at $0.7732, after running into resistance at $0.7765 overnight. A break of support at $0.7724 would risk a return to last week's lows around $0.7650.

The kiwi dollar eased to $0.7178, and further away from a $0.7242 top early in the week.

It has support at $0.7155 and a major chart bulwark around $0.7125.

Markets are counting down to the US consumer price report later in the session where a high reading could rekindle concerns about an early policy tapering from the Federal Reserve and boost the US dollar.

The risk is all the greater as investors seemed to be wagering on a benign outcome with 10-year Treasury yields dropping to a one-month low overnight.

Local bonds performed even better as Australian 10-year yields fell to their lowest in four months at 1.458%, a drop of 18 basis points for the week.

That was the sharpest weekly fall since June last year and took yields 2 basis points below their US counterpart, the first negative spread since March.

The bond rally has been helped by the dogged dovishness of the Reserve Bank of Australia (RBA) which continues to stress that inflation is unlikely to reach its target until 2024, making a rate hike a distant prospect.

David Plank, head of Australian economics at ANZ, has upgraded his forecasts for the economy this year and next, but still thinks a rate hike is two years away.

"The RBA has said it wants to be confident in inflation being sustained above 2% before it raises interest rates for the first time, hence our expectation of the first move not occurring until the second half of 2023," said Plank.

Bonds have also been supported by RBA purchases which are regularly larger than what the government is selling, while banks are so flush with cash their balances at the central bank has expanded to a massive A$275 billion.

So great is the liquidity that cash is being parked in T-notes at negative rates. An auction of A$1 billion in September 2021 notes on Thursday boasted a lofty bid to cover ratio of 8.7 and an average yield of -0.0034%.