Aussie bonds explode to all new highs, more to come

It is the boom without cease. All time new highs for Aussie bonds overnight:

And the slope is still flattening:

Spreads to the US were mixed:

JPM’s Sally Auld says the long end is headed below 1%, my own call from six months ago:

  • The RBA delivered a 25bp rate cut this week, as expected. Subsequent commentary from the RBA Governor has emphasized the likelihood of a follow up cut reasonably soon. We are forecasting the next easing in August, but weak domestic data highlight the risk of an earlier cut, in July. Either way, the narratives we have long expected for Australia in 2019 – weaker economy and RBA easing – are in play. Indeed, this week’s data were unambiguously soft and leave little doubt that significant monetary and fiscal easing will be required if the RBA is to be successful in reducing spare capacity in the economy.
  • Beyond the domestic economy, the new information of late has been a significant shift in the distribution of risks to global growth. This reflects both an escalation in trade tensions, but also a run of softer than expected data which is starting to cast doubt on the resiliency of the global expansion. In recent weeks we have made downgrades to 2019 growth forecasts in the US, China, Europe, UK and Australia. We now expect the Fed to ease 50bp in 2H19, and relatedly, expect the RBA to cut the cash rate to 0.5% by mid-2020 and for the RBNZ to cut the OCR to 1.0% by end-2019.
  • We have made some significant downward revisions to our ACGB yield forecasts, on the back of revised Fed, RBA and UST forecasts. We now forecast the ACGB 10Y yield at 1.00% by June 2020, and for the 3Y yield to reach 0.70% by June 2020. Although it seems to be the consensus view, we do envisage a grinding flattening in the 3s/10s curve in coming quarters, given 1) we don’t expect the RBA to get ahead of the curve with rate cuts; 2) we expect flows to gravitate towards positive carry and/or higher yielding tenors on the curve (which will by definition be longer maturities); and 3) there is limited scope for the real cash rate to fall. At the very least, we think the UST curve could “out-steepen” the ACGB curve in coming quarters.
  • This week we have taken profits on our long in ACGB 3Y yields. While the medium term outlook still argues for strategic longs, the inability of the market to rally given a dovish RBA cut, shifting global risks, weak domestic data and a significant decline in UST yields suggests some sign of near term exhaustion. We will look to re-engage with duration longs in coming weeks, but continue to hold some exposure to lower front end yields via a received position in AUD 6Mx6M OIS.
  • Trade portfolio: Take profits on the long in AUD 3Y bonds, the AUD-NZD 2Yx1Y vs. 1Y box trade and the underweight in the belly of the ACGB Apr-24s vs. Nov-29s and May-21s. Stop out of the paid position in the AUD-USD 10Y bond spread against a received expression in the AUD-USD 1Yx3M spread; the repricing of the UST front end has been painful for this trade. New trades: receive NZD 2Y vs. AUD 2Y swap, pay the AUD 3s/5s curve 1Y forward and receive the belly of the AUD 2s/5s/10s swap butterfly. Hold AUD 3s/10s flatteners, the received position in AUD 6Mx6M OIS, NZD Nov-19 OIS and the received position in the AUD Aug-19 RBA OIS vs. Jun-19 RBA OIS spread. Stay paid AUD/USD 2Yx1Y AUD/USD cross currency basis swap; the recent tightening in funding markets should aid this position. Hold the received NZD-USD 2Yx2Y position.

Strategy Update

  • The RBA cut the cash rate by 25bp to 1.25% this week
  • We expect another 25bp easing in August, although risks of a July cut have risen given weak 1Q GDP data
  • We remain received AUD 6Mx6M OIS, and paid Jun-19 RBA vs. Aug-19 RBA; these trades should perform if the terminal rate grinds lower and if the RBA cuts twice by August
  • We are forecasting a terminal cash rate in Australia of 0.5% by mid-2020; the shift in global growth risks of late and the need for an unemployment rate sub 5% suggest the RBA need to deliver 100bp of easing
  • We have added additional easing in New Zealand this week, and now expect the RBNZ to cut 25bp in August and November
  • We also recently changed our view on the Fed, and now expect 50bp of easing in 2H19
  • Changes to Fed and RBA forecasts, together with changes to UST yield forecasts, have driven some significant adjustments in our ACGB forecasts
  • We now see the ACGB 10Y yield at 1.00% by June 2020, and the ACGB 3Y yield at 0.7% by June 2020
  • The inability of the AUD 3Y bond to rally against a backdrop of significantly lower UST yields, a dovish cut from the RBA and weak data suggests the market looks a little exhausted
  • We therefore trim some of our duration longs, but note that if our mid-2020 yield targets are realized, there is still value in strategic longs in ACGBs
  • This week we highlight some attractive relative value opportunities in AUD rates
  • Changes to the portfolio: Take profits on the long in AUD 3Y bonds, the AUD-NZD 2Yx1Y vs. 1Y box trade and the underweight in the belly of the ACGB Apr-24s vs. Nov-29s and May-21s. Receive NZD 2Y vs. AUD 2Y swap, pay the AUD 3s/5s curve 1Y forward and receive the belly of the AUD 2s/5s/10s swap butterfly. Stop out of the paid position in the AUD-USD 10Y bond spread against a received expression in the AUD-USD 1Yx3M spread

Monetary Policy Update – Lowe gets on the scoreboard, with more to come given soft global and domestic data

The RBA delivered a 25bp rate cut this week, the first move in almost three years. In our view, the Statementsuggests that a follow up easing will come relatively soon; we are forecasting the next move in August, but risks of a July easing have risen. For our thoughts on Tuesday’s decision, see RBA: No longer busy doing nothing, S. Auld, 4 June 2019.

Indeed, the Governor made the case for another 25bp easing clear in a speech after the Board meeting, noting that “…it is not unreasonable to expect a lower cash rate. Our latest set of forecasts were prepared on the assumption that the cash rate would follow the path implied by market pricing, which was for the cash rate to be around 1 per cent by the end of the year.”

The issue is how quickly the next rate cut can be delivered. We’d suggest that pricing for the July meeting looks under-done, especially in the wake of this week’s GDP data. The market should be closer to pricing in a 60-70% chance of an easing next month, rather than the 48% chance currently priced (Figure 1). We have a paid Jun-19 OIS vs. received Aug-19 OIS position which should benefit in the event the RBA cash rate is 50bp lower by the end of August, and this looks more than likely given the tone of the Governor’s commentary and recent global and domestic data outcomes.

Figure 1: AUD OIS curve

RBA meeting date OIS; %

Source: J.P. Morgan.

Figure 2: ANZ job ads have weakened sharply of late

%oya %-pts

Source: J.P. Morgan and Bloomberg.

Indeed, domestic data this week have been soft; ANZ job ads are now running at a -14%oya growth rate (Figure 2), retail sales for April fell 0.1% (a weak start to 2Q), the MI inflation gauge for May was weak (0.0% m/m for both the headline and core measures) and the GDP data revealed that the economy grew a measly 1.8% over the last year. Further, details in the GDP report were soft, with domestic demand rising just 0.1% in the quarter, the household savings rate rising to 2.8% and the annual rate of household consumption a very tepid 1.8%oya. As Figure 3 illustrates, growth has downshifted noticeably and highlights the risk of a terminal rate in Australia which is considerably lower than is currently priced (~0.8%). As we noted in our write up (see Australia: Many rivers to cross in removing excess capacity, B. Jarman, 5 June 2019), the only real positives for growth were government consumption (+0.8%q/q) and exports (+1.0%q/q), both of which added 0.2%-pts (see Figure 4). This raises serious questions about momentum for coming quarters; while government consumption is likely to maintain solid growth on structural factors (NDIS), trade outperformed thanks to a short-term normalization in rural exports, while iron ore and coal shipments are tracking weaker and likely to drag further from here.

Figure 3: Growth in GDP and domestic demand have slowed sharply of late

%oya, both axes

Source: J.P. Morgan and ABS.

Figure 4: Quarterly contributions to GDP


Source: J.P. Morgan and ABS.

The 1Q GDP data leave the RBA needing a +0.85% q/q outcome for 2Q GDP to hit its Jun-19 forecast of 1.75%oya. Given recent trends, this seems highly unlikely. Similarly, the Dec-19 GDP forecast (2.75%oya) requires quarterly average prints of 0.80% q/qfor GDP for the next three quarters, which again appears to be a very ambitious forecast. So one month after the May SoMP forecasts, it seems as if the RBA are already under water on the 2019 growth outlook, which highlights the risk of 3 cuts by year end (relative to the 50bp of easing in total we expect for 2019).

We recently changed our view on the RBA to expect a further 50bp of easing in 1H 2020 (see RBA: Now forecasting a terminal policy rate of 0.5% by mid-2020, S. Auld, 28 May 2019). This was based on an acknowledgement of 1) global growth risks shifting to the downside; 2) the RBA’s admission that NAIRU is now well below 5.0%; and 3) the need for a material decline in the real cash rate. At present, we expect the next 50bp of easing to be delivered in the first half of next year, although there is a risk that this comes sooner if global data soften further. Either way, the trade underscores our strategic received position in AUD 6Mx6M OIS; the terminal rate pricing should be closer to 0.5% than 0.8%.

Forecast changes galore – Fed, US GDP, RBNZ, AUS GDP and more

Since we last published, there have been some significant forecast changes to the J.P. Morgan outlook. We summarise these below:

  • Federal Reserve and US GDP growth: the most important recent forecast change has been the shift in view on the Fed, where we now expect 50bp of easing to be delivered in 2H19 (25bp in September, 25bp in December). See Making Abysmal Growth Attainable, M. Feroli, 31 May 2019. We have also recently downgraded 2Q19 US GDP growth from 2.3% to 1.0% q/q saar; see Deteriorating Q2 GDP should put Fed on watch, M. Feroli, 24 May 2019, and taken a further 0.2%-pts off our 3Q forecast.
  • RBNZ: we have added an additional 25bp rate cut into our forecast, and now expect the RBNZ to ease in August (as well as November). This will take the OCR to 1.0% by end-2019. See RBNZ: Running to stand still, B. Jarman, 3 June 2019.
  • Australian GDP growth: we have made some tweaks to our GDP forecasts for Australia, and now forecast 2019 calendar year growth at 1.9% (prior was 2.1%) and 2020 growth at 3.1% (prior was 2.7%). See Some Australian forecast tweaks reflecting global headwinds, and policy support, B. Jarman, 31 May 2019.
  • European and UK growth forecasts, ECB and BoE: we have revised down growth in both Europe and the UK, and have pushed back expectations of rate hikes from both the ECB (normalization forecast to begin in Dec-20) and BoE (rate hikes to recommence in Aug-20). See Pushing back central bank tightening in Western Europe, M. Barr, 4 June 2019.
  • Asian central banks: we have added more easing to our forecasts for some Asian central banks. This entails 50bp of easing for BI, 25bp of easing for Bank Negara and 25bp for BoT. See ASEAN: Penciling in rate cuts as external risks rise and Fed turns, Sin Beng Ong, 3 June 2019.

Effectively, the message is lower global growth but more supportive monetary policy, either as rate hikes are delayed or new easing is added to the forecast. We have also noted the rise of disinflationary forces (again), notably 1) weaker growth; 2) lower oil prices; and 3) falling inflation expectations; see Daily Economic Briefing, J. Lupton et. al., 3 June 2019). Needless to say, these are significant developments for the RBA, which at some point is likely to be highly sensitive to a shift in risks to the global outlook. It doesn’t feel as if the RBA has yet fully incorporated some of these developments into its outlook (there was little change in the commentary on the global economy between May and June). As Figure 5 illustrates, recent downgrades have resumed the downward trend in our global FRI, with the magnitude of revisions in recent months large by historical context (Figure 6).

Figure 5: J.P. Morgan’s global FRI has resumed its downward trend of late

Global FRI; Index

Source: J.P. Morgan.

Figure 6: And the magnitude of changes have been large

1-month change in global FRI; Index points

Source: J.P. Morgan.

Significant downward revisions to ACGB forecasts – target the ACGB 10Y yield to 1.00% by Jun-20

One consequence of downward revisions to Fed and RBA policy rate forecasts is lower ACGB and UST forecasts. For the latter, we have made some significant changes (see Treasuries: Adjusting our yield forecast lower, J. Barry, 3 June 2019). These changes to our UST forecasts, together with downward revisions to our terminal rate for the RBA, have prompted some significant revisions to ACGB forecasts. We now forecast the ACGB 10Y yield to 1.10% by 1Q20, with the ACGB 3Y yield at 0.60% by 1Q20; see Figures 7 and 8.

Figure 7: ACGB yields; history and forecasts


Source: J.P. Morgan.

Figure 8: ACGB forecasts


Source: J.P. Morgan.

Clearly a big driver of our ACGB forecasts, given the UST forecast, is the forecast for the AUD-USD 10Y spread. The spread has been quite volatile of late (Figure 9), with position adjustment suspected to be the main driver of the recent widening. What is interesting is that the policy rate spread between Australia and the US is not expected to move much from here (a range of -1.00% to -1.25% through to 1Q19). This should suggest a broad range trade for the 10Y spread, and if history is any guide (the spread has traded rich to fair value for the past year – see Figure 10), a range of -50bp to -60bp looks fair. Still, this should be handicapped with the caveat that fair value – using the regression in Figure 10 – should be closer to -20bp to -30bp.

In addition, the yield curve forecast for Australia also matters; we have forecast a gradual grind flatter in the ACGB curve, largely because 1) we don’t expect the RBA to get ahead of the curve with rate cuts; 2) we expect flows to gravitate towards positive carry and/or higher yielding tenors on the curve (which will by definition be longer maturities); and 3) there is limited scope for the real cash rate to fall. The risk to this view is our sense that flatteners are the consensus trade in AUD rates (given recent conversations with investors, both offshore and domestic) and that there could be scope for steepening in the UST curve if the Fed easing cycle turns out to be more aggressive than we currently forecast.

Figure 9: The AUD-USD 10Y spread has had a sharp correction in recent weeks

AUD-USD 10Y spread; Bp

Source: J.P. Morgan.

Figure 10: RBA-Fed policy rate spread vs. AUD-USD 10Y spread

10Y spread; regression is monthly data since Jan-95

David Llewellyn-Smith

David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal.

He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.

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