Westpac: Have Inflation Fears Peaked?

Westpac note that “5y5y BEI has been turning down from its recent highs and is now back into the upper end of the long-term range. This suggests that, now that the RBA has begun its tightening cycle, some of the inflation uncertainty/market premium has been recalibrated lower. Historically that would also be associated with flatter curves on average. To the extent that the re-pricing is linked to the expectation that the RBA will deliver a front-loaded tightening cycle, a flatter curve should be the medium-term result. The backdrop, of course, is that the RBA is now moving in line with the Fed and domestic curve outcomes will remain very correlated with the U.S. The AU 3-/10-Year & U.S. 2-/10-Year bond curves are highly correlated, with a linear regression since the beginning of 2018 showing an R-squared of 0.8816. The AU curve is marginally too steep on this basis, however, any medium-term analysis will really depend on the U.S. Our Fed view and the risks to it all point in favour of a flatter U.S. curve, which will provide the lead for the AU curve.”