Australia: Challenging the consensus on the 10y AU-US spread – RBC CM

Research Team at RBC Capital Markets, suggests that at 43bp, the benchmark 10y AU-US spread is not far from its tightest level since April 2015.

Key Quotes

“Policy divergence is likely to keep the bias toward compression, but a number of factors suggest that further substantial and sustained AU outperformance is unlikely.

History suggests that the RBA-Fed Funds rate needs to turn negative in order for the 10y AU-US spread to move into a sustained 0–50bp range. This is not our base case and we remain with our long-held target for RBA cash at 1.50% by end 2016 and end 2017. Add to that maturing offshore demand, a persistent structural Federal budget deficit underpinning record issuance, and a less robust AAA sovereign rating and there would appear to be a number of headwinds.

Accordingly, we expect the 10y AU-US spread to remain in a broad 40–60bp range over the next 12 months, with the risk that it tests last April’s low (~36bp) following the next cut. We think it is worth considering a contrarian tactical trade to sell this spread at these lows.”