Will inflation get the RBA and RBNZ to tango? – TDS

Analysts at TD forecasts both the RBA and the RBNZ to hike the cash twice in May and Nov next year and suggests that the key driver for both Banks to hike next years is a build in inflationary pressures.

Key Quotes

“Right now the market is placing very low odds to both Banks hiking as per TD’s forecasts so our bias would be to be positioned short duration. Our conviction to be short duration is stronger on NZGBs given expansionary fiscal policy, rising inflation risk and 10yr NZGB model estimates that are more aggressive than the forwards.”

“Curves in Australia and NZ are steeper than we would expect to see during periods of neutral RBA and RBNZ policy. This suggests that Aus and NZ curve steepening should be limited ahead of potential RBA and RBNZ hikes. Our model for the ACGB 3s10s curve points to limited steepening while the magnitude of steepening is expected to be greater in NZ on fundamentals and model estimates.” 

“Supply dynamics continue to remain supportive for semis, with the AA states (that are favoured for yield) well ahead of the pro rata run rate for 2017/18 fiscal issuance. There is also a risk that semi issuance this fiscal year falls short of planned issuance - this should be supportive for semis overall. We expect strong demand for longer dated semis to persist next year. For the AOFM we forecast no change to planned issuance, but the focus is moving to issue into the longer dates. Meanwhile NZGB issuance is expected to rise to NZ$10b / yr.” 

“Australian 3yr swap spreads are trading around fair now, but Australian 10yr swap spreads are trading 4bp below fair, so we are better payers of long end swap spreads right now. Our work shows that 3yr swap spreads traditionally hit a low anywhere between 2-5 months before a RBA hike and given the 3s10s bond-swap box peaks in the months preceding an RBA hike, this suggests the direction for swap spreads is wider not narrower at least over the 1st half of the year.”

“On cross market spreads, we expect 10yr ACGBs and NZGBs to underperform relative to USTs this year but our conviction levels to position for this move are stronger on NZUS than on the AU-US right now. The fall out of this is that we continue to like NZ-AU wideners given NZGB 10yrs are trading rich vs our model estimates and expansionary NZ fiscal policy adds to inflation risk.”