Dovish RBA, cheap JGBs
FX: AUD is falling on a dovish RBA
The Australian dollar is weighed by expectations for a dovish Reserve Bank of Australia meeting today. The AU 10Y bond yield has slipped to new record lows below the 1% cash rate target since August 7. The 2Y yield is lower at 0.73%. The RBA’s “forward guidance” has made its policy intentions more transparent. Lately, it has become more open about rates falling to 0.50%, a level that it would consider, if needed, quantitative easing. The cash rate was lowered twice in June-July by a total 50bps. The RBA also considers a weaker AUD helpful to the economy, which it sees significantly threatened by the trade war.
GDP data release on September 4 is likely to disappoint. Prime Minister Scott Morrison has warned of a “very difficult” second quarter. On a QoQ basis, growth may come in negative vs the +0.5% consensus from a shocking drop in 2Q business inventories (-0.9% QoQ actual vs +0.3%), weak construction activities and slow consumer spending. Growth, in YoY terms, could be the worst since the global financial crisis. PM Morrison wants to return the budget to a surplus and is resisting calls for more stimulus, hoping for tax cuts and the RBA’s rate cuts to help growth in the second half. Hence, we expect RBA monetary easing expectations to pressure AUDUSD into a lower 0.60-0.65 range.
Rates: JGBs are relatively cheap
Global sovereign bonds are pricing in a worrying global economic outlook and a decent amount of monetary easing ahead. Thus, valuations are likely to be fairly rich unless one assumes that the global slowdown is going to worsen considerably from here, in which case would warrant central banks to ease aggressively. In such a challenging environment where there is not a lot of value to be found, investors can consider bonds that may not be cheap, but that are cheaper.
We think JGBs are that – not cheap, but cheaper. Because of the restrain posed by BOJ's Yield Curve Control (YCC) policy, yields have fallen much less and slopes have flattened much less compared to elsewhere. Year to date, within G10, JGB yields have fallen the least. 10Y JGB yields are 27bps lower vs peer average of 97bps. 2Y/10Y JGB slope is 12bps flatter vs peer average of 42bps.
On a FX-hedged basis, JGB yields have risen to the top of standings, from middle of the pack at end-2018.
The window of opportunity to lock in relatively high JGB yields could be closing though. 10Y yields have been trading below the -0.20% lower bound of YCC target range since August 9. The BOJ has tried to defend the bound by reducing its purchases, but the downward pull on JGB yields by global yields has proved to be too strong. At its upcoming policy meeting on September 19, the BOJ could widen or lower the 10Y JGB target range, which could see yields gap lower, possibly by 5-10bps.
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