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.

 

  •   15 January 2025
  • 1
  •      
  •   

RELATED ARTICLES

Shares rebound on hopes of war ending, but stalemate the likely outcome

Clime time: Has Australia wasted the last 30 years?

No one holds the government to account on spending

banner

Most viewed in recent weeks

Why spending more in early retirement can improve lifetime income

Conventional wisdom encourages retirees to preserve superannuation. But if those likely to qualify for the Age Pension later in life spend a little more today, it may deliver higher lifetime income and a more stable retirement.

Testamentary trusts have secured the CGT exemption

Treasury’s latest CGT reform draft delivers a win for testamentary trusts and deceased estates, exempting estate-derived gains from the 30% floor. However, questions on death and divorce rollovers remain unresolved.

Meg on SMSFs: What do we think about reversionary pensions these days?

Reversionary pensions have long been a staple of SMSF estate planning, but are they still the best option? Meg Heffron revisits a once-clear favourite and asks whether changing super rules have shifted the balance.

Is it time to bail on Australian stocks?

For generations, Australian investors have backed banks, miners and dividends. But has that loyalty come at a cost? A look at the numbers raises an uncomfortable question about where future returns will come from.

Testamentary trusts survived the trust tax. The drafting battle has just begun.

The fight over testamentary trusts looked settled. Then the draft legislation arrived. Hidden in a technical detail is a question that could force many families to rethink wills they thought were already future-proof.

How does the 4% rule stack up?

The 4% rule has long been retirement's gold standard. But after a difficult period for investors, fresh analysis suggests a more conservative approach may significantly improve the chances of making savings last.

Latest Updates

Planning

How the typical Australian Family could save $844,350 in taxes

The value of a testamentary trust is not determined by wealth alone. Depending on circumstances, it can reduce the tax burden on inherited income, create efficiencies and help build intergenerational wealth.

Superannuation

There's a reason why your super is locked up until your 60s

For decades, it seemed settled. Then one controversial idea reignited a debate that could reshape the financial future of millions. The real question isn’t who’s right or wrong, but whether a long-held assumption deserves another look.

Property

The housing slide could become a crash

House prices are sliding across Australia, yet the most dangerous ingredient for a housing crash is still missing. If job losses surge amid growing economic risks, today's correction could become a historic property downturn.

Retirement

Under-retiring: The greatest retirement risk in a generation

Two retirees. Similar savings. Completely different lives. New research from Challenger reveals why some Australians confidently spend in retirement while others hold back and the overlooked factor shaping retirement decisions.

Five risks to watch in markets

Things you may often hear are: a recession is around the corner, markets are overpriced, the AI sector is about to flop at any moment. It’s like the never-ending laundry pile that sits in my house, it never really disappears.

Investment strategies

Do you qualify as ‘rich’?

What does it mean to be 'rich'? For something so universally desired, it is surprisingly difficult to define. That ambiguity creates a challenge for investors and raises a bigger question about what financial success really looks like.

Investment strategies

If you’re worried about your bond portfolio, you’re missing the point

Most investors think they know what bonds are for. But when markets turn volatile, a surprising misunderstanding can lead to costly decisions. Here’s the overlooked lesson that could change how you view your portfolio.

Alliances

  • ASA-Logo-RGB-ActiveGreen-web.png

© 2026 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.