Originally published by Commonwealth Bank of Australia
In our last ‘great rates expectations’ we spoke of 3 elephants. And we penned the risk of each elephant being a reflection of a darker, sinister swan. Today we speak of the growing change in risk. We highlight our lowered swap forecasts. And we go through our trade recommendations. Our trade recommendations are designed to ride the elephants and hedge the swans.
1. On Thursday, we updated our bond forecasts in “Short back and sides, and a little off the top”. In our prior forecast review in December, we had expected UST yields to be 15‑40bps higher by today. The inability of the Trump administration to deliver initiatives has underwhelmed. So has growth and inflation. Federal investigations into the White House have only added uncertainty. Talk of impeachment has reduced yields. The pull back in yields is symptomatic of the lower for longer world in which we live. Our forecast trajectory heads in a similar direction, but we’ve taken a little off the top. We also updated our thoughts on swap spreads following the sharp move lower in Libor‑OIS spreads. See “I won’t back down: the outlook for Australian swap spreads and the box.” Bringing the two together, our swap forecasts are presented at the back.
2. The themes we presented in December are still in play, and include: upside risks to US yields, a rise in term premium, steeper Antipodean curves, offset by persistent impact from regulation and demographics.
3. Yields remain in an upward trajectory. The angle of ascension, however, is simply more gradual. Our trade recommendations this year have performed well, but not well enough. We strip back to the bare bones, and flesh out our strategic thoughts into trade ideas. We continue to favour paid positions in US rates. We add another Aussie swap curve steeper. And we enter another AUD/USD spread compression positon. Our OIS positions are well and good. And we kick off with a look at market pricing across the main markets we love.
Market expectations for the US Fed have been forced higher by the delivery of hikes. Well at least in the near term. The “terminal” rate reflected in the US rates market is little changed, however (chart 1). We prefer to pay US rates on the risks of more Fed hikes, and the impending unwind of the Fed’s $4.5trn balance sheet. In Australia, the outlook for the RBA has not changed. But market pricing for the RBA has been through a rollercoaster. We play stability in Antipodean cash rates. We prefer to use Aussie and Kiwi OIS as a hedge to any black swans that may appear out of nowhere.
Please click below to continue reading: