Westpac: How Far Can AU Cross Market Spreads Widen?

Westpac note that "the benchmark 10-Year AU-U.S. bond spread has widened by around 20-25bp over the past month or so. That is a reversal of the narrowing trend that began in Q2, and when we deconstruct the nominal spread into its relative real yield and relative inflation components, we can see, that the nominal widening is being driven by a widening of the real spread."

• "In our view, that is a function of expected strength of the post-lockdown rebound and Australia's accelerated vaccination rate, which is giving us confidence that the 2022 growth profile should be strong and sustained with minimal interruptions of the type seen in 2020 and 2021. Even so, we do question just how wide the spread can move from current levels. The RBA's QE purchases are still running at a faster pace than issuance, and there is some scope for ACGB issuance to be revised lower at the MYEFO."
• "The recent widening has cheapened AU bonds against other AAA nations and also peripheral Europe, placing AU bonds in a better position to attract investment flows in an environment of improved yield alternatives. The currency has also strengthened in the light of the commodity cycle. So, all that is needed is for global yields to settle on their new ranges and then the AU market can become a greater focus. We expect that support to begin to manifest itself around 20bp in the AU-U.S. 10-Year spread."