RBC: Is There Still Value In ACGBs If Yields Move Below USTs?

RBC note that "a tightening in the AU/US 10y yield spread from ~30bp earlier this year to around flat has had many investors questioning whether there is still value in the Australian market, especially when the policy rate differential has also disappeared. We believe there is a solid case to argue for further narrowing, helped by the currency hedged yield equation in particular demonstrating why the economics of persistently negative nominal spread can still stack up. 10 year hedged ACGBs still yield more than just about every other core developed sovereign market. Their pickup over USTs/GoCs/NZGBs is currently about 30bp, and over core European markets (gilts, bunds, OATs) at least 50bp. This is because despite the nominal spread generally compressing to other markets, A$ funding has become cheaper. A US dollar holder can pick up almost 30bp (annualised) by swapping into AUD for a 3m term, an attractive yield enhancement trade which is likely also driving demand for front-end A$ products such as t-notes and short ACGBs despite single-digit nominal yields at these tenors. We also note that amongst one of the most important currency-hedged buyer cohorts, Japanese investors, demand for A$ bonds has been consistently elevated since April. With hedged yields still relatively high (the hedged pickup over JGBs ranges from 50bp in 10y ACGBs to 90bp in 20-30y) we anticipate this continues to drive cross-border flow, despite a stronger AUD/JPY probably tempering unhedged demand. A tightening demand/supply dynamic in A$ bonds over the next year including likely negative net issuance after RBA & balance sheet purchases will also keep downward pressure on the nominal AU/US spread."