Australia, NZ dollars fall, bond yields spike as Mideast war rages on

Oil surge lifts inflation risk, Aussie 3-yr bond yield hits 15-year high
NZ two-year swap rates jump 14 bps to tighten financial conditions
Rate hike bets for RBA, RBNZ building but growth concerns weigh

By Stella Qiu

SYDNEY, March 9 (Reuters) - The Australian and New Zealand dollars resumed their slide on Monday as oil prices vaulted over 20% on the risk of a lengthy Middle East war, sending domestic bond yields surging on renewed inflation fears.

With no sign of an end to hostilities in the Middle East and tankers still not daring to cross the Strait of Hormuz, investors were bracing for a long stretch of higher energy costs.

Brent (LCOc1) jumped 22% to $113.36 a barrel, having already soared 28% last week. U.S. West Texas Intermediate (WTI) crude (CLc1) futures were up 24% to $113.46. Asian stocks plunged, with Japan’s Nikkei (.N225) down 7%. (O/R) (MKTS/GLOB)

Often sold as a proxy for global risk, the Aussie (AUD=D3) fell 0.9% on Monday to $0.6964, after weakening 1.1% last week to as low as $0.6945. With the drop on Monday, it has broken out of the recent trading range from around 70 to 71.5 cents, with risks now tilted towards further weakness ahead.

The kiwi dollar (NZD=D3) was down 0.7% at $0.5853, after falling 1.6% last week to as far as $0.5837, which is now the near-term support. Beyond that, there is little support until $0.5712.

Joseph Capurso, head of international economics at the Commonwealth Bank of Australia, said the Aussie has succumbed to weakness, though it did take a few more days longer than he expected given the perception that Australia is a net energy exporter.

“We expect more escalation of the conflict between the combatants before deescalation… AUD/USD is not a safe haven and so will fall further as the conflict escalates,” he said in a note to clients.

Surging oil prices have led bond markets to reprice global inflation risks, sending bond prices tumbling. However, sustained rises in oil prices act as a tax on households and businesses, ultimately weighing on global growth.

Three-year Australian government bond yields (AU3YT=RR) surged 16 basis points to 4.592%, the highest since mid-2011. Ten-year government bond yields (AU10YT=RR) gained 13 bps to 4.977%.

Swaps imply there is an almost 40% probability that the Reserve Bank of Australia will have to hike interest rates to 4.1% this month, while a move in May has been fully priced in. (0#AUDIRPR)

Across the Tasman Sea, two-year swap rates (NZDSM3NB2Y=) jumped 14 bps to 3.2338%, the highest since June last year, while 10-year yields (NZ10YT=RR) are up 14 basis points at 4.655%.

Markets imply a total tightening of 43 bps from the RBNZ this year, though the central bank has said even one rate hike is not fully baked in. (0#NZDIRPR)

“Yes, inflation will likely spike further in the near term… We suspect central banks, and the RBNZ in particular, may well have to tolerate higher inflation in the short run to avoid tightening into a slowing global economy,” said Jarrod Kerr, chief economist at Kiwibank.

(Editing by Muralikumar Anantharaman)