Goldman: Distance From RBA Mandate Argue For Fading Front-End

Goldman Sachs note that "with no expected policy changes at this week's RBA meeting, the focus will likely be on any signals given around the future of the YCC and QE programs. Heading into the meeting, AUD front-end rates fully discount a 15bp hike by mid-2022, and a total of 110bp of hikes by the April 2024 bond maturity date. This looks extreme relative to the Bank's latest cash rate guidance and our economists' own view for lift-off criteria to only be met in 2024. We expect the Bank to manage market expectations lower over time as the Bank reiterates the long timeline to full employment and at-target inflation, and reinforces YCC target (the April 2024 bond) despite a firmer near-term outlook. Similar to the U.S., we see front-end pricing as somewhat boxed in (though in Australia's case, by the enforcement of YCC) and believe there is attractive carry at the front end. Furthermore, relative to the U.S., the greater inflation shortfall and labor market slack also argue for a later timeline for policy normalization in Australia, and we see the taper timeline in the U.S. constraining lift-off there to no earlier than late-2022/early 2023 (indeed, market pricing appears sticky at early 2023). A likely further expansion of the QE program size by the RBA would also solidify any inner bound on the lift-off timeline. As a result, we think that the high level of premium in front end AUD rates (some of which is possibly on account of hedging flows) can be monetized, and therefore recommend entering 2y1y/5y5y AUD swap steepeners. The short further out the curve should serve to insulate against any bearish foreign spillovers without substantially eroding carry at the front end. The QE top-up discussed above should have relatively limited impact on the 5y5y point, as RBA purchases have tended to focus on maturities 7y and in."