Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 594

Beware the bond vigilantes in Australia

In September 2022, the UK government released a budget update and economic plan. By mid-October 2022, both the Prime Minister and the Chancellor of the Exchequer had resigned due to the significant increase in borrowing required to fund the new fiscal policies, which led to a substantial sell-off of UK government bonds and skyrocketing yields. 

More recently, following the outcome of the US Presidential election, there has been close monitoring of US fiscal policy and its implications for bond issuance in 2025 and beyond. However, one market that hasn’t seen as much focus is Australia. Could this be about to change?

Elevated Government spending

The RBA Governor, Michelle Bullock, mentioned the higher-than-expected growth in government spending in Australia in a recent press conference. In fact, the RBA has highlighted the high level of government spending several times over the past few months.

Exhibit 1 below shows Australian domestic demand by sector. The private sector is reducing its spending in response to higher interest rates, which is helping to rebalance the economy. The economy was growing at an above-trend rate for several quarters, and this triggered the most severe bout of inflation seen in decades. But while the private sector is adjusting, the combined government sector continues to spend at elevated levels.

Exhibit 1: Australian Domestic Demand by Sector, 2007 Q1 – 2024 Q2

Source: Franklin Templeton, Australian Bureau of Statistics, Macrobond.

This spending is broad-based. At the national level, the spending shows in government-related employment growth, particularly in the health care industry. However, high commodity prices over the past few years have boosted revenue and led to a national budget surplus. If only this were the whole picture…

In Australia, a significant portion of government spending occurs at the state and territory level. And this is where the numbers aren't so rosy. Some states, such as Western Australia, are reporting strong budget surpluses due to high commodity prices. Conversely, other states are reporting large deficits as soft property markets limit revenue growth and large investment pipelines boost expenditure growth. The fact that many of these projects are behind schedule and over budget exacerbates the situation.

When we examine the effective level of government borrowing, it becomes clear that the states and territories are living beyond their means at a time when the RBA is advocating for more frugality.

Exhibit 2: Australian Government Borrowing, 2005 Q1 – 2024 Q2

Source: Franklin Templeton, Australian Bureau of Statistics, Macrobond.

Bond issuance is key

But what does this have to do with bond vigilantes?

It is all about bond issuance. In the early stages of the pandemic, both the national and state/territory governments increased bond issuance to finance assistance packages. This was paired with the RBA purchasing government bonds as part of its response to the pandemic. Remember 'Team Australia'! 

Since then, national government bond issuance has normalised. In fact, it is running below the pre-pandemic level thanks to the tailwinds noted above. In contrast, state and territory governments are issuing a significant amount of debt at a time when the RBA is transitioning from being a net buyer of bonds to a net seller. This is when bond vigilantes pay close attention.

Exhibit 3: Australian Government Bond Issuance and Central Bank Purchases, 2005 Q1 – 2024 Q2

Source: Franklin Templeton, Australian Bureau of Statistics, Macrobond. Note: State and Local includes issuance by Central Borrowing Authorities.

Whilst we do not manage portfolios against a UK government bond benchmark, it is safe to assume those benchmarks performed poorly in late 2022 amidst the bond market turmoil. 

When considering the outlook for Australian government bond benchmarks, specifically the AusBond Composite Index, we are particularly concerned about the level of bond issuance from the states and territories.  These issuers, collectively termed the 'Semi-Government' sector, have shown a preference for issuing mid- to longer-dated bonds, i.e., 5- to 15-year maturities, as illustrated in Exhibit 4 below.

This trend does not bode well for the performance of the AusBond Composite Index and arguably goes some way to explaining its relatively poor performance, despite many central banks commencing rate-cutting cycles.

Exhibit 4: Australian Government Bond Issuance by five Largest ‘Semi-Government’ Issuers, 2020 – Present

Source: Franklin Templeton, Bloomberg.

Global bond markets have their fair share of headwinds at present.

The US government is issuing record amounts of debt, with neither major political party showing interest in balancing the budget. Japan might finally tighten its monetary policy, reversing a strategy that flooded the local market with liquidity and compelled Japanese investors to be net buyers of global government bonds. 

Additionally, the demand for capital from the private sector is likely to increase to finance clean energy investments. All these factors suggest that interest rates will remain higher than pre-pandemic levels. 

Against this backdrop, Australia's state and territory issuers need to find buyers for their bonds. The national government is also just an iron ore price drop away from needing to issue a much larger amount of bonds. Fixed income can still serve as a defensive asset class, but perhaps not in benchmark form. Beware the bond vigilantes.

Joshua Rout, CFA is a Portfolio Manager and Research Analyst at Franklin Templeton Fixed Income. Franklin Templeton is a sponsor of Firstlinks. This material is intended to be of general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell or hold any security or to adopt any investment strategy. It does not constitute legal or tax advice.

For more articles and papers from Franklin Templeton and specialist investment managers, please click here.

 

RELATED ARTICLES

It's the cost of government, stupid

Reality bites

7 questions, 70 opinions on major policies facing Australia

banner

Most viewed in recent weeks

Raising the GST to 15%

Treasurer Jim Chalmers aims to tackle tax reform but faces challenges. Previous reviews struggled due to political sensitivities, highlighting the need for comprehensive and politically feasible change.

Here's what should replace the $3 million super tax

With Div. 296 looming, is there a smarter way to tax superannuation? This proposes a fairer, income-linked alternative that respects compounding, ensures predictability, and avoids taxing unrealised capital gains. 

100 Aussies: seven charts on who earns, pays, and owns

The Labor government is talking up tax reform to lift Australia’s ailing economic growth. Before any changes are made, it’s important to know who pays tax, who owns assets, and how much people have in their super for retirement.

The rubbery numbers behind super tax concessions

In selling the super tax, Labor has repeated Treasury claims of there being $50 billion in super tax concessions annually, mostly flowing to high-income earners. This figure is vastly overstated.

9 winning investment strategies

There are many ways to invest in stocks, but some strategies are more effective than others. Here are nine tried and tested investment approaches - choosing one of these can improve your chances of reaching your financial goals.

With markets near record highs, here's what you should do with your portfolio

Markets have weathered geopolitical turmoil, hitting near record highs. Investors face tough decisions on valuations, asset concentration, and strategic portfolio rebalancing for risk control and future returns.

Latest Updates

Taxation

100 Aussies: seven charts on who earns, pays, and owns

The Labor government is talking up tax reform to lift Australia’s ailing economic growth. Before any changes are made, it’s important to know who pays tax, who owns assets, and how much people have in their super for retirement.

7 key charts on the state of the Australian property market

The Australian property market stirs fierce debate - often bullish optimism versus crash predictions. But beyond the noise, seven charts reveal what's really driving prices and the outlook for residential real estate.

A simple alternative to the $3 million super tax

Division 296 aims to introduce improved fairness into the superannuation system, yet is overly complex. This scours the world for better ideas and suggests a simpler alternative which can achieve the same goals.

CBA and the index conundrum for super funds

After the hyperbolic rise in CBA shares, super funds are floating the idea of carving out the weightings of ASX bank securities and indexing them within their portfolios. This looks at why that might be a big error.

Strategy

10 policies to drive Australian productivity higher

Here's a comprehensive list of proposed reforms to fix Australia's stagnating economy, including introducing a flat income tax rate, reducing migration, and making childcare tax-deductible.

Interviews

Where to find big winners in Asia

As more money looks for a home outside the US, Asia may soon get some love. Fidelity's Anthony Srom outlines the best places in Asia to invest, including in Chinese consumer names, Indian financials, and Thailand.

Investment strategies

We have trouble understanding the time value of money

We overvalue the present and underestimate the future - it’s a cognitive glitch called hyperbolic discounting. It affects savings, spending, and loans, and it's more common - and costly - than we think. 

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.