The Australian dollar continued to fall today, sparking the biggest one-day sell-off in government bonds since the turmoil in global markets that followed the collapse of US investment bank Lehman Brothers in late 2008.
Bond traders said the sell-off was triggered by weakness in US Treasurys in Asia but exacerbated by the fall in the Australian dollar, which has prompted market participants to lower expectations of a further cut in interest rates by the Reserve Bank of Australia.
The Australian dollar has fallen by 11 per cent since the start May due to a number of factors, the most significant being moves by the US Federal Reserve to tell markets it intends winding back economic stimulus before the end of the year.
Australian 10-year government bond futures fell 26 basis points today to be trading at 95.97 late in the Sydney trading session. Meanwhile, the Australian dollar was plumbing fresh 33-year lows trading at US91.67c, down from US92.50c on Friday.
David Plank, debt strategist at Deutsche Bank, said trading conditions were the worst in the bond markets since October 2008, when global markets were in chaos.
But as the Australian dollar has fallen, concerns about Australia's economic outlook have begun to ease. The Aussie had been trading above parity with the US dollar for much of the last two years even as commodity prices had been falling, putting a squeeze on the economy and sending unemployment higher.
The RBA has cited the high currency as a key factor in driving benchmark interest rates to record lows. Financial markets had been expecting the RBA to continue cutting rates in the coming months, but the bets have now been scaled down.
Pricing in interest rate markets now assumes just one more cut in rates before the end of the year. The policy setting board of the RBA next meets on July 2.
Peter Dragicevich, currency strategist at Commonwealth Bank, said the fall in the Australian dollar would be attracting the attention of the central bank as it restores confidence and bolsters the economy generally.
"The currency has been the key focus for the RBA. As the currency declines, monetary conditions loosen, so it does negate the need to cut interest rates further," he added.
CBA is still betting that the RBA will cut rates again in August from 2.75 per cent to 2.50 per cent, but Mr Dragicevich said the level of the currency at the time of the policy meeting then might be a determining factor against it.
Concern about a developing credit crunch in China was also weighing on the Australian dollar. The nervousness fed into regional sharemarkets and savaged commodity prices. Australian shares fell to close at their lowest levels in six months.
Any move to curb credit growth in China will immediately rebound on the Australian dollar and Australian-denominated assets, said David Scutt, currency trader at Arab Bank.
"But while it'll be detrimental short-term, it may well be a blessing in disguise if it reduces the likelihood of an ever larger crisis down the line," Mr Scutt added.
China's state-run Xinhua News Agency indicated over the weekend that Beijing won't be taking action soon to ease the tight liquidity, which investors worry may damp base metal demand.
