Via UBS:
AUD & NZD: Upside risks to front-end NZD rates; RBA QE + CLF = lower AU 10y
The RBNZ hasn’t been providing a forecast path for the OCR for the quarters after March-21; but we expect this to change at the 11 November MPS (see here for our preview). If the RBNZ refrains to provide a (lower) forecast path for the OCR post Q1- 21, we think that markets would interpret that as a signal that the FLP has reduced the urgency to cut rates. This could drive a material sell-off in front-end rates, given that markets have currently priced ~40bps of cuts by August-21. In such a scenario, the upside pressure on short-term rates is likely to be intensified by an increase in pay flows due to mortgage fixing. On the back of these risks, we close our Rec RBNZ Feb-21 meeting OIS with a small loss of -2bps. In Australia, the focus will remain on RBA QE, with the Bank set to buy $5bn/week of AGS in the <12yrs sector ($4bn of ACGBs and $1bn/week of semi-government bonds). We think that RBA buybacks will be skewed to the ~10yr point; and we expect the 3s10s curve to flatten towards 50bps from here. Demand for 10yr ACGBs will also be supported by the forthcoming changes to the RBA’s Committed Liquidity Facility (CLF). With these two drivers likely to drive strong demand, we recommend buying ACGB 10y bond yields. We like to express this trade against UST 10yr as a hedge for a steepening in global curves. In the semi space, next week we get the Budget updates for the Northern Territory, South Australia (both on 10 Nov) and Tasmania (12 Nov).
Following the release of the Commonwealth Budget, the AOFM confirmed that they will gross issue $240bn of nominal bonds in FY-21. So far in FY-21, the AOFM has issued~$135bn. This means the AOFM is ahead of its required task, so it can now slow its pace of issuance sharply, to ~$3.5bn/week from ~$8.1bn/week YTD.
• While supply slows, demand should remain bid. First, we continue to expect strong demand from ADIs on the back of the unwinding of the CLF. Importantly, at its meeting in November, the RBA committed to do proper QE: over the next ~6 months, the RBA is on track to buy $80bn of ACGBs in the 5-12yr sector. As free-float shrinks, we expect the whole ACGB curve to shift lower and bull-flatten.
• The move lower in AUD 4y2y IRS should be facilitated by the expansion in the RBA ES Balances, which should see front-end OIS trade towards 0bps (the current deposit rate) and the OIS fwd curve flatten out. BOB is also likely to remain very low at ~6bps
In the case of the US, the announcement of QE has often marked the bottom of yields as markets have discounted it already and then shifted to anticipating inflation. In Australia’s case, there are reasons to think that UBS is right:
- Aussie long-end yields are still the highest in the developed world;
- the growth and inflation outlook is poor despite the virus success owing to crashed immigration, the Depressionberg Unstimulus, peak household debt (notwithstanding mortgages) and China decoupling all meaning a structural adjustment will be required;
- US and global yields will likely fall ahead as the Atlantic economies fall prey to the virus again and fiscal stimulus fails to keep pace triggering more monetary easing.
