Westpac On Recent Roll & EFP Dynamics

Westpac note that "due to the steepness of the curve, and the shift in make-up of the basket bonds, the 3-Year roll especially is very large. That, along with the evolution in expectations for a YCC extension (from the RBA), has been a complicating factor for traders and investors hedging their positions and looking for the best time to shift their positions into the next contract. Specifically over the past fortnight, June 3-Year futures have rallied substantially. That has pushed the 3-Year swap EFP wider than might have been expected, as swap rates have moved differently. One of the reasons for this is that the 3-Year swap EFP will move narrower as a result of the roll. Traditionally, when that has occurred, despite it being a logical shift, the market has had a tendency to move the spread back toward its old level. As a result, there has been buying of the Sep futures and paying swap. Will that continue? We suspect it will, however, whether it will move back to positive levels is largely a function of the underlying bond relative value. The basket has unwound expensiveness but is not cheap and the prospects of a range-trade suggest that carry-related receiving will remain in favour. That should cap the Sep 3-Year swap EFP around 0bp near term."