Westpac: When Will AU Cross Market Spreads Begin To Perform?

Westpac write, “many observers have noted that the “beta” between U.S. and AU rates has been relatively high, especially at the front end of the curve. The question is whether this will start to slow, especially given the significant RBA profile already factored in. If Westpac is right, and the cash rate moves to 0.50% by year end, well short of current expectations, then there is room for outperformance across the curve.”

• “The benchmark AU-U.S. 10-Year bond spread has moved out to the 18-20bp range but has been relatively range-bound in recent months. Given that the AU bond market is a high yielding AAA, which has traditionally been an attractive mix for investors, it is interesting to compare the spread to U.S.-Bund differential. The latter has been edging higher, which has attracted talk that a bid for U.S. Tsys might arise on any sustained move toward 200bp on the spread. There is a broadly inverse relationship between moves in each spread. So if the move toward 200bp is undertaken in an orderly U.S.-led sell-off, then AU bonds will have the opportunity to outperform.”
• “Looking at the AU/U.S. 1Y1Y and 5Y5Y swap spreads it is notable that the 1Y1Y has narrowed back to 0bp, which we think will eventually extend to at least -20bp. However, the catalyst for this will be a revision to RBA pricing, which is unlikely near term. Meanwhile, the 5Y5Y spread is near its widest levels over the past two years. We think that it should also narrow, on the same driver as the shorter spread - a repricing of RBA expectations.”