Sell Kiwi And Buy Aussie
Jarrod Kerr | Sep 07, 2017 16:39
Originally published by The Commonwealth Bank of Australia h2 Aussies and Kiwis are close, but not that close. Sell Kiwi and buy Aussie 2021s./h2
Aussies and Kiwis are (too) close. We are best unbeaten brothers in battle, but relentless rivals in relative rates. The NZGB‑ACGB differentials are too narrow. So we sell Kiwi May‑21s and buy Aussie May‑21s. At just 5bps, we like the risk/reward.
The rally in USTs have left ACGBs behind. The spread between ACGBs and USTs have widened beyond recent ranges. NZGBs have moved more in line with USTs, and outperformed ACGBs. ACGBs have been left flapping in the wind. We are long ACGB to USTs, and we think it’s time to add the Kiwi side.
We always expect Kiwi outperformance on a rugby field, but we don’t always expect Kiwi outperformance in bonds.
We’re ANZACs in war, but rivals in rates.
The spreads between Aussie bonds and Kiwi bonds have collapsed. And the widow‑maker, AUD/NZD, has lifted to 1 year highs. Earlier this year, the markets had the risk of a 2017 RBNZ rate hike priced, and the NZGB‑ACGB 2021 spread widened to +67bps (figure 1). The widow‑maker threatened parity, again. Reality slowly crept back into markets as the RBNZ confirmed a neutral, and certainly not hawkish, bias. Now, the economic momentum has since swung in favour of Australia. Figure 2 shows the Citigroup (NYSE:C) data surprise indices have swung in favour of Australia. We believe markets have gone too far. This time we favour higher Kiwi rates to relative to Aussie. And it’s a timely position into the election.
The last time the ACGB‑NZGB spreads collapsed to these levels, the RBA had embarked on a mining related tightening cycle in 2009 (independent to NZ). Differentials worsened in the aftermath of the 2010/11 Canterbury earthquakes. The trough in NZGB‑ACGB spreads coincided with the RBNZ’s emergency 50bps cut on 10th March 2011.
Today, both central banks are in a similar position. Indeed we forecast a similar trajectory for both the RBA and RBNZ. From current levels, we expect extended stability over 2018, followed by a very gradual normalisation to lower levels of neutral. We expect the RBNZ cash rate (currently 1.75%) to remain 25bps above the RBA cash rate (currently 1.5%) over the foreseeable future. The RBA is unlikely to rise back up above the RBNZ, at least until 2019 (at the earliest).
Trade recommendation: buy and sell Antipodean 2021s
We RV scan the Aussie and Kiwi government bond curves individually, and come up with one conclusion: buy ACGB May 2021s and sell NZGB May 2021s (see figures 3 and 4).
We recommend entering the ACGB‑NZGB spread position at just +5bps, target a move back out to +25bps (current cash rate differential), and hold a stop of 0bp.
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For those worried about the upcoming election, a similar position in the 2027s would also benefit more from thoughts of fiscal deterioration. Term premium could be added to the +10‑year section of the curve with a Labour victory. The NZGB 2033s are also “dear” on the RV scan, but the bond is less liquid.
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