Fixed Income: Weekly Strategy

Transcription

1 5 March 212 An avalanche of news slated to hit the market this week Multiple Central Bank meetings, GDP, Labour Force, Payrolls and a Greek vote are all scheduled this week. AUD/USD bills/libor spreads are likely to contract from historically wide levels, but only modestly. We review the shape of the semi curves and find the QTC Nov-14 looks very dear compared to other QTC bonds. Despite an improvement in sentiment, the success of the ECB s second LTRO and the run of positive Central Bankers speeches last week, the price action in bonds has been muted. Since last Monday, the US 2Y has rallied 3 to.27%, while the US 1Y has sold-off 1 to 1.97%. In Australia, the 3Y futures have sold-off 6, to while the 1Y has sold-off 3 to The lack of reaction in bonds to the newsflow is, perhaps, not that much of a surprise. Since the start of the year sentiment has been improving substantially but the actual price impact of that sentiment change has been mixed. Some bonds have reacted hugely, while others, particularly the highest grade bonds, have changed remarkably little. For example, since late November 211, the Italian 2Y has rallied nearly 6, but the US 1Y has been range-bound between 1.8% and 2.1%. The 2Y bund has kept rallying despite the improvement in sentiment. Improving market sentiment has supported AUD SSA issuance volume in recent weeks, but challenges remain. On page 3, Alex Stanley discusses recent issuance flows and the impact on basis spreads. Other issuance last week included a new NSWTC Feb-17. On Page 8 Philip Brown discusses the shape of the semi curves and finds the QTC Nov- 14 is particularly dear. This week there is a lot of news and much of it should be positive. The RBA and the RBNZ both meet this week. Given Governor Stevens tone at the Economics Committee, we very much doubt the RBA will cut rates this month. An upbeat statement is likely. Similarly, the RBNZ is very likely to leave the overnight cash rate unchanged. There will also be important data prints like Australian GDP (Wed) and Labour Force (Thurs). The consensus for Australian GDP is a.7% rise but CBA is expecting a slightly better result of +.8%. The Labour Force data will be intriguing. After a significant period of weakness the last print was quite strong, but may have been an outlier. CBA are predicting the unemployment rate will remain unchanged at 5.1%, but consensus is for a slight up-tick to 5.2%. The US payrolls data is scheduled for this Friday. Most indications are for another strong number and consensus is currently for 21K jobs, but no change in the 8.3% unemployment rate. If that isn t enough for you, the deadline for investors to accept the Greek Private Sector Involvement is Thursday. Contents: Key Positions... 2 Key Trades... 2 Issuance flows and bills/libor basis spreads (First published on March 2)... 3 Assessing the shape of the Semi curves: QTC Nov-14 very dear. (First published on March 2)... 8 Key Views CBA Forecasts: Calendar March Net issuance flow impacting on the 5Y basis A$bn Source: CBA, Bloomberg Net Issuance Flow (LHS) 5yr Basis (RHS, Inverse) As we noted, market pricing has, in the main, reacted little to the change in sentiment (so far). Predicting when the market pricing might break the support and start a strong-sell-off is very difficult. We are happy with our current positions, which are slanted to the short side, in both Australia and the US. (We are paid AUD OIS, paid AUD vs NZD swap, received EFPs and long Aus vs US at 1Y). Adam Donaldson Head of Debt Research T E. adam.donaldson@cba.com.au Philip Brown Quantitative Strategist T E. philip.brown@cba.com.au Alex Stanley Associate Analyst, Fixed Income T E. alex.stanley@cba.com.au Important Disclosures and analyst certifications regarding subject companies are in the Disclosure and Disclaimer Appendix of this document and at This report is published, approved and distributed by Commonwealth Bank of Australia ABN AFSL

2 Key Positions There s a lot happening this week: RBA, RBNZ, GDP, labour force, payrolls, before you include European affairs such as the Greek PSI vote. Although the sentiment is improving significantly, the yields on US bonds (and even Aussie bonds) haven t reacted too much (yet). We re happy maintaining our overall short position. We have a number of trades that are slanted to perform better in a sell-off (AUD-NZD swap, Aust-US 1Y bond spread), as well as an outright short via the forward starting OIS. We have not changed our portfolio very much this week, adding only a single trade. We have bought the QTC Oct-15 against the QTC Nov-14 (see page 8 for details). This trade, too, has a bearish slant as a slight flattener. Because the QTC slope is relatively stable, we implement the trade with twice the normal exposure per basis point. Key Trades Trade Entry Curent Profit Target Stop Comment Buy the TCV Jun-2 vs NSWTC May-2 Buy the ACGB Apr-23 versus the Apr-2. Pay the 5Y in the AUD 2Y/5Y/1Y butterfly Buy the WBC Feb-17 covered bond against the NAB Mar-18 Buy a 6M put on the Oct-14 bond at a strike of 4.1%.5 (16-Nov-11) 31 (12-Jan-12) +1.5 (23-Jan-12) 3 (25-Jan-12) 5 premium (9-Feb-12) Buy a 2 OTM conditional bull 6 premium steepener. (2.9 times 3.31% call (9-Feb-12) on Apr-15 and 1. times 3.89% call on Jul-22. Implicit slope 58). Enter a 2Y/1Y NZD swap steepener Buy the QTC Jul-22 against the NSWTC Mar-22 Buy the ACGB Jul-22 vs the UST Feb-22 Receive 3Y EFP Buy the NSWTC Nov-25 Linker against the ACGB Apr-27 Nominal Pay the AUD 2Y*1Y swap rate against NZD 2Y*1Y swap 145 (1-Feb-12) 51 (15-Feb-12) 217 (15-Feb-12) 61 (2-Feb-12) 24 (2-Feb-12) 59 (25-Feb-12) Pay 6M*6M OIS 3.91% (27-Feb-12) Buy the QTC Oct-15 against the Nov-14 (2% exposure) 25 (2-Mar-12) Hold: TCV s AAA is safe and the funding task is modest. NSW is subject to some rating risk Hold: RV analysis reveals the Apr-23 is cheap against the Apr Hold: RV scan suggests butterfly is too low Hold: We believe covered bonds should outperform other fixed rate senior bonds. 3.74% Hold: The bearish side of a pair of trades to protect against tail risks. Rates could pop higher if Europe remains calm. Current slope: 48 (well OTM) Hold: The bullish side of a pair of trades to protect against tail risks Hold: The NZ curve seems poised to steepen if the global recovery continues Hold: QTC has stabilised the liabilities to revenue ratio Hold: Our new bond forecasts suggest the US yields could underperform AUD Hold: As sentiment improves the 3Y spread should drop Hold: We expect breakevens to rise and semis to outperform Hold: AUD to NZD 2Y*1Y has fallen in last weeks, but is generally trending up 3.95% % 3.71% Hold: We think the RBA has one more rate cut in them, at most. If we are at a turning point, (2% exposure) New Trade: The QTC NOV-14 is very dear and we expect curve flattening. 2

3 Issuance flows and bills/libor basis spreads (First published on March 2) Alex Stanley Associate Analyst, Fixed Income alex.stanley@cba.com.au AUD/USD bills/libor spreads are near historically wide peaks. Until recent weeks, net issuance flows have been skewed towards Australian bank offshore deals. An improvement in SSA pricing supports some further increase in onshore deal flow from SSAs, but swap collateral issues will continue to present a barrier in the long run. After a significant increase in covered bond deals of late, Australian bank offshore issuance volumes aren t likely to be as strong in the near future, leaving scope for Kangaroo issuance to move bills/libor spreads tighter. We expect 5-1Y basis spreads to tighten modestly in the short term, but to hold above the trading range seen through most of 211. Australian dollar cross-currency basis swap spreads have widened to historically wide levels since the start of 212. The major driver of the recent move has been the large volume of offshore issuance by Australian banks. Meanwhile, issuance inflows from Kangaroos have been comparably light. A few Kangaroo deals have come to the market in recent weeks, but the traditionally active SSA issuers have been quieter than normal so far in 212. Financials are nowhere to be seen. Figure 1 shows that late 29 was the only time that bills/libor spreads were wider than current levels. This period also corresponded with a surge in Australian bank offshore issuance, amid limited inflows from Kangaroo issuers. The 29 peak in bills/libor spreads proved only temporary, as the Government Guarantee expired and bank offshore issuance quietened down. Meanwhile, SSAs and other Kangaroo issuers took the advantage of the wider spreads and increased their presence in the AUD market. We assess whether the current elevated level of the basis spread will also prove to be temporary. History has shown that one needs good knowledge of deal flow to gauge the major moves in basis spreads. For this reason, picking the basis swap direction is difficult. With that caveat in mind, we assess the landscape for issuance flows into and out of the Australian dollar market. We see some scope for further SSA issuance in the near term. This should see bills/libor spreads retreat from their peaks. In the long run, we see good reasons for a higher trading range for bills/libor, given obstacles for SSA issuance in AUD and the continuing need for Australian banks to issue offshore. Figure 1 AUD/USD Bills/Libor Spreads yr 3yr 5yr -6 1yr Source: CBA, Bloomberg Figure 2 AUD/USD and AUD/EUR 5Y Basis Spreads 1 5 AUD/EUR daily Source: CBA, Bloomberg AUD/USD 3

4 Basis spreads widened in early 212, from very low levels. SSA issuance flow was limited until February. Early 212 issuance flows: quieter than recent years The wider bills/libor spreads in early 212 stand in stark contrast with late 211 levels near zero. Flows in and out of Aussie dollars were virtually absent in late 211 (Figure 3). Basis traders essentially viewed the market for Aussie bank offshore issuance as closed due illiquidity and to the extreme widening of global financial credit spreads at the time. The new year brought easier market conditions for Australian banks and, importantly, large deal flow. The ECB s LTRO and CBA s covered bond deal helped to break the hiatus, allowing Australian banks to price over USD 8bn worth of foreign deals mostly in new covered bond programs in January and February. A large chunk of the flow was in Euros. What s striking about deal flow in January 212, compared with the start of previous years, is the absence of Kangaroo issuance, especially from traditionally dominant SSAs (Figure 3). In February, SSAs returned to the market, but still not in the volumes that we ve seen at the beginning of recent years. Meanwhile, banks stayed active in February, pricing USD 3.8bn of offshore covered bonds. Is there still value for SSAs in the Kangaroo market? Figure 3 Australian onshore and offshore Issuance flows* A$bn KANGAROO ISSUANCE *Data is not a complete record of all issuance into and out of AUD due to private placements, etc. Source: CBA, Bloomberg Jan- 1 Jan- 11 Jan- 12 A$bn yr yr yr -25 OFFSHORE Net Flow -25 ISSUANCE -3-3 Jan-8 Jan-9 Jan-1 Jan-11 Jan-12 There are three main factors that have recently constrained Kangaroo issuance volumes: AUD SSA liquidity, European sovereign risk and swap collateral costs. (1) AUD SSA liquidity Figure 4- Net issuance flow and 5Y basis A$bn Net Issuance Flow (LHS) 1 5yr Basis (RHS, Inverse) AUD SSA pricing have improved since 211 In late 211, the narrower basis swap (Figure 1) proved to be the lesser barrier to SSA issuance in Aussie dollars. The major obstacle was the wide level of SSA spreads in AUD, with some spreads marked at over 2 above swap (Figure 5). Liquidity was very light and so exaggerated the degree of widening during the most extreme moves in November (2) European sovereign risk Beyond the liquidity issues, there was also uncertainty in investor s minds about how the European sovereign crisis would play out and, in turn, affect SSA ratings and creditworthiness. This concern has also been a driver of wider SSA spreads, especially European names. Figure 5 also shows that Washington name SSAs were less affected Source: CBA, Bloomberg 6 Most SSA Spreads, especially European names, have narrowed since November. The better performance largely reflects an improvement in the European sovereign risks, 4

5 Issuance is still cheaper for non- Euro SSAs. Higher swap costs are a barrier to SSA issuance. following the LTROs. To a degree, SSA ratings uncertainty has also lessened. For example, EIB, one of the largest issuers, had its AAA status with S&P affirmed in January, albeit with a negative outlook. Figure 6 gives an example of how tighter AUD secondary spreads and wider cross-currency basis spreads have improved the value prospect for two SSA issuers, relative to 211. Cheaper deal costs probably explain the modest pickup in deals in February. We think more SSA issuers are likely to step into the market and take advantage of the better levels. As we write, ADB and Rentenbank have just returned to the Kangaroo market after a long hiatus. However, we expect the pace of SSA issuance to remain modest compared with the first few months of recent years (Figure 3). Spreads and underlying demand for SSA paper in the AUD market will need to recover to make AUD issuance attractive (especially for European issuers). The examples in Figure 6 show that the AUD market isn t as cheap for SSAs as the late 29 period, when the cross currency basis was last around these wide levels. (3) Swap collateral costs Counterparty risk has become a bigger concern for all banks since the Lehmans collapse in 28. Collateral agreements for swaps help banks manage counterparty risk. Recently, the issue of swap collateral has grown in relevance for banks intermediating SSA deals in Australia. This concern over collateral may have increased because of regulatory proposals for derivative markets, such as Dodd-Frank regulations in the US. Also, Basel III proposals include a charge for Credit Valuation Adjustment (CVA), which means banks now have an extra incentive to manage counterparty risk in derivative transactions. One method of reducing counterparty risk is through collateral agreements. But many SSA borrowers are often not required to post collateral under Credit Support Annex (CSA) agreements with banks. However, banks still have to post collateral to SSAs under the same agreement and with other banks in offsetting trades. The one way nature of the agreements with SSAs means that banks potentially incur an additional funding cost from swaps. These costs affect cross currency basis swap pricing. These problems are likely to persist indefinitely and are likely to reduce the volume of SSA deals in the AUD market. At present, the size of the extra cost depends on a number of methodological, firm and counterparty-specific factors and so is not uniform. For this reason, it s difficult to fully quantify the extent to which Figure 5- SSA AUD pricing (spread to swap) Jul-9 Jan-1 Jul-1 Jan-11 Jul-11 Jan-12 Source: CBA IADB Supra (Feb-21) IADB Supra (Aug-19) IBRD Supra (Oct-19) Figure 6 Estimated AUD funding advantage for IBRD and KFW* KFW (Aug-2) *Calculation takes into account asset swap spread differentials, 3/6s basis and cross-currency basis spreads for respective currencies Source: CBA, Bloomberg IBRD Nov-16 AUD v USD KFW Jul-16 AUD v EUR EIB Supra (Aug-19) KFW (Dec-19) EIB Supra (Aug-2) IBRD Supra (Oct-2) -6 Jan-9 Oct-9 Jul-1 Apr-11 Jan-12 5

6 Australian bank offshore issuance will remain the dominant flow, but it may take time for more deals to come to the market. higher swap costs will limit SSA issuance. But it does seem likely that swap costs will eventually reduce the basis swap value proposition of the AUD market. In this regard, issuers who only target the AUD market opportunistically when the basis spread is attractive may issue less frequently or in smaller volumes. Therefore, we think the one-way CSA issue may be one factor that prevents basis spreads from trading back within their stable, mid-21 to mid-211 range (Figure 1) in the foreseeable future. Aussie bank offshore issuance will remain the dominant flow, but perhaps not right away Australian bank offshore issuance has traditionally been the dominant flow impacting bills/libor basis spreads. We expect this to remain the case. As Figure 7 illustrates, Australian banks have sizeable maturities still to come this year. But banks have issued large volumes of covered bonds thus far in 212. We think they re likely to step back from issuing aggressively offshore in the near term. Longer term, beyond re-funding of maturities, banks may not be as aggressive in issuing offshore as they were in past years. They have reduced their reliance on wholesale funding (Figure 8). This process has been aided by the deleveraging trend in the Australian economy over recent years. Figure 9 shows that the deposit to lending gap has narrowed over the last year following a major increase in 29. So marginal growth in lending is being funded by deposits, resulting in the net decline in bank bond issuance seen in Figure 7. We see little reason to expect this trend to turnaround quickly given ratings and liquidity pressures to increase deposit ratios. So less offshore wholesale funding may be required than in recent years. Nonetheless, the longer term prospects for AUD bank offshore issuance look brighter than for SSA inflow. Figure 7 Australian bank issuance & maturities A$bn Guaranteed Unguaranteed -2 Net MATURITIES * As at early February 212 Source: CBA, Bloomberg ISSUANCE Figure 8 Bank now less reliant on wholesale funding Figure 9 Major bank deposit and lending growth Bills/Libor spreads have scope to tighten modestly in the short term. Outlook for bills/libor spreads The bills/libor market is experiencing a hangover from the January covered bond deals and a dearth of supply from traditionally active SSA issuers. This combination has left longer term bills/libor spreads at historically wide levels. A tightening of SSA spreads and a wider basis swap has made SSA issuance more attractive. The emergence of SSA issuers in February and a few new deals announced in recent days suggests the market is at least on the road to repair. In our view, there is scope for further SSA deals in the short term, as risk appetite improves and AUD SSA spreads recede towards more normal $bn month change (rhs) Jan-7Jan-8Jan-9Jan-1Jan-11Jan-12 Source: CBA, APRA Deposit-lending gap (lhs) $bn

7 levels. This issuance, amid weaker issuance by banks, should exert some downward pressure on bills/libor spreads. However, we don t think bills/libor spreads will rapidly return to the mid- 21 to mid-211 trading range. The deals are likely to be more sporadic than in the past. Longer term, we re less confident about the prospects for SSA issuance to drive tighter basis swap spreads. Our central expectation is that SSA spreads, especially European names, will continue to tighten towards more normal levels. However, there may continue to be some lingering concern about liquidity and longer term credit worthiness of European SSAs. This concern could present itself in bouts of volatility in SSA spreads again in the future, if European sovereign risks flare up. This could inhibit issuance. Also, higher swap costs are a potential barrier to higher SSA issuance volumes. We suspect that large SSA issuers will continue to print deals in AUD, as some regard the AUD market as a core source of funds. But higher swap costs could reduce the scope for smaller issuers, opportunistically entering the market. Figure 1 Longer term bills/libor spreads have widened the most in recent months yr 5yr 1yr Dec-1 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Source: CBA, Bloomberg Our view is that bills/libor spreads will tighten in the short term. We think there s some value in receiving the 5-1Y part of the bills/libor curve, which has widened the most of late (Figure 1). But we think this move will be limited and spreads will probably only tighten as far as 5-1 to the 25-3 level. We think the 5-1Y bills/libor spreads aren t likely to recede to the lower range that characterised the second half of 211 for the foreseeable future. 7

8 Assessing the shape of the Semi curves: QTC Nov-14 very dear. (First published on March 2) Philip Brown Quantitative Strategist philip.brown@cba.com.au The NSWTC curve is quite stable despite the new bond. QTC Nov-14 looks very dear versus other QTC bonds. We recommend selling the Nov-14 against the Oct-15 The long end of the ACGB, NSWTC and QTC curves are all dear at around 8Y with the 1Y looking cheap. There s been a solid sell-off over the past few days and a new NSWTC bond too. We thought now would be a good time to check the shape and pricing of the various semi-curves. Surprisingly, the new Feb-17 NSWTC is not cheap (normally, new bonds are) and the NSWTC curve is fairly priced in an RV sense. However, we did find that the QTC Nov-14 was very dear. We recommend buying the QTC Oct-15 against the QTC Nov-14 at a spread of 25. More interestingly, we noticed that many curves seem to have an unusually steep section between about 22 and 222. This seems strange to us, but may be a function of investor mandates. NSWTC curve new bond already at a fair price We fitted a Nelson-Siegel curve to the NSWTC bonds expecting the Feb-17 to be a little cheap. After all, it is a brand new bond. In fact, it was completely fair in our model. The most interesting result on the NSWTC curve is the dearness of the May-2 bond. We have noticed a number of curves have this property, which is more than a little strange. This long-end anomaly is addressed below. Queensland curve Nov-14 very dear To be honest, the title says it all. The QTC Nov- 14 is very dear. Figure 2 shows the results of the Nelson Seigel fitting procedure and the kink after the Nov-14 is obvious. For confirmation, Figure 3 shows the cheap/dear of the bonds against the fitted curve. The Nov-14 is over 6 cheap. That s a very large signal from a Nelson-Siegel fit. The question is how to structure the trade to capture the best profit from the anomaly. The two most obvious options are spread trades between the Nov-14 and either the Aug-13 or the Oct-15. We tend to think the slope against the Oct-15 is probably best. There are RV, strategic and technical reasons to use the Oct- Figure 1: NSWTC Nelson-Siegel Fit Actual Yield Fitted Yield Source: Bloomberg, CBA Figure 2: QTC Nelson-Siegel Fit Actual Yield Fitted Yield Source: Bloomberg, CBA 8

9 QTC Nov-14 to Oct- 15 QTC slope much steeper than ACGB slope 15. The RV reason is shown in Figure 3, too. The Oct-15 is cheap compared to the curve. The Aug-13 is cheap too, but not as much as the Oct-15. (As a side point, note that the Jun-21 looks dear compared to the Jul-22 as well, but we ll get back to the long end soon.) The strategic reasons go back to our overall view on the economy and on semis. We think the front end of the curve should sell-off and flatten (see Strategy Weekly of 27 February). We have previously recommended paying the 6M*6M OIS because we thought the front-end was pricing too many RBA rate cuts. We generally look for a sell-off and flattening of the curve, which makes us prefer to use the Nov-14 to Oct-15 spread (a flattener) than the Aug-13 to Nov-14 spread (a steepener). These bonds are very close to each other, so an overall change in slope doesn t affect the result too much. But it s still better to have a basis point or two of benefit than a basis point or two of headwind. The second structural reason to buy the Oct-15 rather than the Aug-13 is the credit curve. We have detailed our reasons for expecting the QTC credit curve to both tighten and flatten in previous research (see The State of Play of Semis published on 15 February). There is more space for the Oct-15 credit to tighten than the Aug-13. Since we generally expect the QTC credit to tighten, this argues for using the longer-date bond, too. The final point is a technical reason. Figure 4 shows the divergence in behaviour between the QTC Nov-14 to Oct-15 slope and the ACGB Oct-14 to Oct-15. Quite clearly the QTC spread has not been flattening as quickly as the ACGB, even steepening in the last few weeks. We think the overall trend should reassert, though. We recommend buying the Oct-15 QTC against the Nov-14 QTC at a spread of 25. We target a spread of 17, with a stop at 29. Because the spread is relatively stable, we implement the trade with twice the normal exposure per basis point. The 1Y conundrum why are 22s looking dear to 222s so often? We have observed above that both the NSWTC curve and the QTC curve have a strangely dear 8Y bond. They re not alone. The ACGB curve has a similar kink. (See Figures 5 and 6.) The ACGB Apr-23 is, according to our approach, the cheapest bond on the curve, while the Apr-2 is the dearest. We have previously noted this feature of the ACGB curve Figure 3: QTC Nelson-Siegel Cheap/Dear <- Expensive Cheap -> Nelson-Siegel Cheap/Dear Result Jul-22 Jun-21 Feb-2 Feb-18 Apr-16 Oct-15 Nov-14 Aug-13 Apr-12 Source: Bloomberg, CBA Figure 4: QTC and ACGB slopes QTC Nov-14 to Oct-15 slope 4 ACGB Oct-14 to Oct-15 slope Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 Source: Bloomberg, CBA Figure 5: QTC and ACGB slopes Actual Yield Fitted Yield Source: Bloomberg, CBA 9

10 and recommended that exact trade, Apr-2 to Apr-23, on 12 January. The trade has actually succeeded (despite the current RV results) because the overall curve has flattened. It should be pointed out that the swap curve does not show such a kink between 8Y and 1Y. Neither does the TCV curve, nor the WATC. Still, ACGB, QTC and NSWTC are three very important curves to all be displaying such a strange coincidence. First off, we can confirm that the ACGB results are not due to distortion by the exceptionally long Apr-27. We get almost identical results if we leave the Apr-27 out of the analysis. Nor can long bonds be distorting the QTC or NSWTC curves. This dearness of the 22 maturities is more than just an oddity it actually violates an arbitrage condition in bond pricing. A straight yield curve allows you to form a portfolio with positive yield, no duration and positive convexity. At the moment, the arbitrage is fully available only on the ACGB curve, though the NSWTC curve goes close. (See Figure 7) Figure 6: QTC and ACGB slopes <- Expensive Cheap -> Source: Bloomberg, CBA Nelson-Siegel Cheap/Dear Result Apr-27 Apr-23 Jul-22 May-21 Apr-2 Mar-19 Jan-18 Jul-17 Feb-17 Jun-16 Apr-15 Oct-14 Jun-14 Dec-13 May-13 The only explanation we can propose is that there are a number of fund managers whose mandates allow only a strict 1Y as the longest bond. These managers could not buy the 222 bonds, because they are slightly longer than 1Y. The extra demand for the 8Y and 9Y bonds might be enough to cause the distortion. We re happy to stick with our Apr-2 to Apr-23 ACGB flattener, though it might be the case that Apr-2 to Jul-22 trade would pay off more quickly as the latter bond comes within the 1Y bucket.. Figure 7: Arbitrage in the ACGB curve, nearly in the NSWTC curve Yield Duration Convexity Weigting Portfolio ACGB Jan Yield 4.4 ACGB Apr Duration 6.66 ACGB Jul Convexity.57 Yield Duration Convexity Weigting Portfolio NSWTC Feb Yield 4.84 NSWTC May Duration 6.35 NSWTC Mar Convexity.51 Yield Duration Convexity Weigting Portfolio QTC Feb Yield 5.18 QTC Feb Duration 6.27 QTC Jul Convexity.51 Source: Bloomberg, CBA 1

11 \\\ Global Markets Research Key Views United States Tactical (<1 mth) Strategic (>3 mths) Recent US economic data argues for higher yields. The recovery in the labour market continues, with the unemployment rate falling from 9.% last September to 8.3% in January. US inflation remains stronger than Fed forecasts. The core CPI results are still trending higher, making it hard for the 1yr BEI to hold much below 2%. Treasuries remain well bid due to the ongoing crisis in Europe, the Fed s already-implemented Operation Twist and the promises of further easing if required. The FOMC has indicated it is unlikely to tighten until the end of 214. We increased our US rates forecasts substantially because the ongoing recovery in US growth could combine with a market-perception that the Fed is being too stimulatory and cause a large sell-off. The global risk appetite is also generally increasing (though risks remain) so this shouldn t constrain a sell-off in Treasuries. We believe the increased size of the ECB s balance sheet (via LTROs and sovereign debt purchases) relative to the US Federal Reserve balance sheet, will help guide EUR/USD lower over the coming months. We expect USD/JPY to keep rising, as the JPY adjusts to a host of structural and cyclical factors. USD/JPY lifted 7% during February, and we expect further gains over coming months. We continue to anticipate the USD to remain firm until mid-212 for the following three reasons: (1) The US economy is out-performing most of the G7, most notably the Eurozone, UK and Japan; (2) USD support will be maintained with underlying concerns about Eurozone economic developments; and (3) USD funding demand remains firm. Policy rate.1%.1% 1yr bond 2.1% 2.2% 2/1 curve USD/JPY EUR/USD Australia Tactical (<1 mth) Strategic (>3 mths) The RBA cut rates in November and December, citing a lower inflation outlook. But the RBA didn t cut again in February (contrary to market expectations), due to greater confidence in Europe and the global economy. Recent weakness in the labour market (broader view), inflation, house prices and activity data could leave the door open for one more easing, at most. Our economists forecast a 25 cut in May. But the odds of multiple cuts have clearly receded and it would now take a significant turn for the worse in Europe to see the market price in more than 1-2 cuts. The potential for a further rate cut and capital flight from Europe will generally keep quality bond markets well bid. However, bonds have lagged the general pick-up in risk appetite in 212 and seem overdue for a corrective sell-off if negative news doesn t flow soon. Bonds do look expensive versus the cash-rate outlook and alternative AUD high-grade bonds. We expect AUD to remain heavily influenced by offshore developments, particularly in Europe, over coming weeks. We have lifted our near-term AUD forecasts for three main reasons: (1) The global growth outlook has stabilised and is starting to improve; (2) Commodity prices are likely to remain supported by ongoing relatively solid growth in China and elsewhere in Asia; and (3) The RBA has indicated there is a high bar to further rate cuts. Policy rate 4.% 4.% 1yr bond 4.1% 4.3% 3/1 curve yr EFP yr v US AUD/USD New Zealand Tactical (<1 mth) Strategic (>3 mths) The NZ economy is slowly recovering, but, like Australia, is suffering from global uncertainty. Recently, the Q3 GDP figures showed signs of underlying momentum in the economy were reinforced by the retail sales data. The RBNZ indicated global developments remain the dominant factor for interest rates. The first half of 212 looks too soon for the RBNZ to be fully convinced the risks to the global economy have sufficiently eased, even assuming Europe contains the crisis. Domestically, there is also uncertainty regarding the pace of the Christchurch rebuild. The latest inflation data affirms our view that the RBNZ will be in no hurry to lift the cash rate from 2.5%. We expect a gradual tightening cycle, and expect the OCR eventually peak at 4.% in late 213. Improved risk appetite and easing market volatility have guided the NZD higher over 212. Stabilisation in the global growth outlook should support New Zealand-specific commodity prices. As the pace of New Zealand s economic growth picks up further, we expect the market to reinstate pricing for increases in the RBNZ cash rate from late 212. These developments support our higher NZD outlook Policy rate 2.5% 2.5% 1yr bond 4.% 4.1% 2/1 swap curve yr v US yr v AU 1 3 NZD/USD AUD/NZD

12 Cash Rate Pricing Australian Cash Rate Pricing New Zealand OCR Pricing US Fed Funds Pricing Cum. % chance Cum. % chance Cum. % chance Rate of +25 Rate of +25 Rate of +25 Current 4.22 Current 2.5 Current.12 3-Apr Mar Mar May Apr Apr Jun Jun Jun Jul Aug Jul Aug Nov Sep Sep Jan Oct Oct Mar Dec Nov Jan Dec Mar AUD Implied Cash Rate Mar May Jul Sep Nov Jan Mar NZD Implied Cash Rate Mar May Jul Sep Nov Jan Mar USD Implied Cash Rate Mar May Jul Sep Nov Jan Mar Candian Rate Pricing EUR EONIA Pricing UK SONIA Pricing Cum. % chance Cum. % chance Cum. % chance Rate of +25 Rate of +25 Rate of +25 Current.99 1W repo.14 Current Jan Mar Mar Mar Apr Apr Apr May May Jun Jun Jun Jul Jul Jul Sep Aug Aug Sep Sep Feb Oct Mar Nov CAD Implied Cash Rate Mar May Jul Sep Nov Jan Mar EUR Implied Cash Rate Mar May Jul Sep Nov Jan Mar GBP Implied Cash Rate Mar May Jul Sep Nov Jan Mar Source: All data sourced from Bloomberg. Rates displayed are calculated using IB Futures (Australia), FF Futures (US) and OIS in all other currencies. 12

13 CBA Forecasts: Cash rate 5-Mar Mar-12 Jun-12 Sep-12 Dec-12 Mar-13 Jun-13 Sep-13 Dec-13 US Australia Requesting New Zealand United Kingdom Germany Japan Canada yr bond yield 5-Mar Mar-12 Jun-12 Sep-12 Dec-12 Mar-13 Jun-13 Sep-13 Dec-13 US Australia New Zealand United Kingdom Germany Japan Canada yr bond yield 5-Mar Mar-12 Jun-12 Sep-12 Dec-12 Mar-13 Jun-13 Sep-13 Dec-13 US Australia New Zealand United Kingdom Germany Japan Canada Currencies 5-Mar Mar-12 Jun-12 Sep-12 Dec-12 Mar-13 Jun-13 Sep-13 Dec-13 Mar-14 AUD/USD AUD/JPY AUD/EUR AUD/GBP AUD/CAD AUD/NZD USD/JPY EUR/USD GBP/USD USD/CAD NZD/USD

14 Calendar March 212 Monday Tuesday Wednesday Thursday Friday Early April Central Bank Meetings 1 2 AU Building approvals, Feb (2 April) AU RBA (6 March) A U AI-Group P M I, Feb, Index, (51.6) CH Non-M anuf PM I Feb, Index, (52.9) AU Retail Trade, Feb (3 April) EZ ECB (8 March) AU Capex, QIV, q/ y%ch,., (12.3) JP CPI, Jan, y%ch, (-.2) AU Trade Balance, Feb (4 April) UK BOE (8 M arch) A U RP Data house prices, Jan, m%ch, (-.2) EU PPI, Jan, m/y%ch, (-.2/4.3) AU Housing Finance (11 April) CA Bank of Canada (8 M arch) A U Build approv, Jan, m%ch, 5., (-1.) UK PM I construction, Feb, Index, (51.4) AU Labour Force, M ar (12 April) NZ RBNZ (8 M arch) NZ Terms o f Trade Index, QIV, q%ch, (-.7) CA GDP, QIV, q%chsaar, (3.5) JP BoJ (13 March) CH PM I M anufacturing, Feb, Index, (5.5) US FOM C (13 M ar) JP Vehicle sales, Feb, y%ch, (4.7) EU/GE/UK PMI manufacturing, Feb, Index, (49/5.1/52.1) US Total vehicle sales, Feb, mn, (14.13) US Construction spending, Jan, m%ch, (1.5) US ISM manufacturing, Feb, Index, (54.1) US Personal income/spending, Jan, m%ch, (.5/.) US PCE deflator/core, Jan, y%ch, (2.4/1.8) CA Current account, QIV, $CAbn, (-12.1) AU CBA/Ai-Group Perf of Serv Index, Feb, (51.9) AU RBA cash rate, %, 4.25, (4.25) A U Ai-Group P CI, Feb, Index, (39.8) A U Labour Force, Feb A U Trade balance Jan, $ bn, 1.4, (1.7) AU TD inflat gauge Feb, m/y%ch, (.2/2.2) AU Current acc deficit, QIV, $ bn, -9.3, (-5.6) A U GDP, QIV, q/y%ch,.8/2.5, (1./2.5) employment, ', 15, (46.3) NZ Credit card spending, Feb, m%ch, (1.) AU Company profits, QIV, q%ch, -3.5, (4.8) AU Net export contrib, QIV, ppt,., (-.6) A U RBA Dep. Gov. Lowe speaks in Sydney unemployment rate, %, 5.1, (5.1) CH PPI/CPI, Feb, y%ch, (.7/4.5) AU Inventories, QIV, q%ch,.7, (-1.1) EU GDP, QIV, q/y%ch, (-.3/.7) JP Leading / Coincident index CI, Jan, (94/93.6) participation rate, %, 65.3, (65.3) CH Industrial production, Feb, y%ch, (12.8) AU ANZ Job ads, Feb, m%ch, (6.) GE Factory o rders, Jan, m/y%ch, (1.7/) NZ RBNZ o fficial cash rate, %, 2.5, (2.5) CH Retail sales, Feb, y%ch, (18.1) EU PM I services/composite, Feb, Index, (49.4/49.7) US Consumer credit, Jan, US$bn, (19.3) NZ M anufacturing activity QIV, q%ch, () GE Trade bal, Jan, bn, (12.9) EU Retail sales, Jan, m/y%ch, (-.4/-1.6) CA Building permits, Jan, m%ch, (11.1) JP GDP, QIV, q%ch, (-.6) UK Industrial production, Jan, m/y%ch, (.5/-3.3) GE/UK PMI services, Feb, Index, (52.6/56) JP Curr a/c total/adjusted, Jan, bn, (33.5/752.3) UK PPI Input/Output/core, Feb, y%ch, (7./4.1/2.4) US ISM non-manufacturing, Feb, Index, (56.8) JP M achine tool orders, Feb, y%ch, (-6.9) UK Total trade balance, Jan, bn, (-1.1) US Factory orders, Jan, m%ch, (1.1) EU ECB announces int. rate, %, 1., (1.) US Trade balance, Jan, US$bn, (-48.8) GE Industrial production, Jan, m/y%ch, (-2.9/.9) US Non-farm payrolls, Feb, ', (243) UK BoE announces rates, %,.5, (.5) US/CA Unemployment rate, Feb, %, (8.3/7.6) CA Bank of Canada, %, 1., (1.) CA Trade balance Jan, C$bn, (2.7) JP M achine orders, Jan, m/y%ch, (-7.1/6.3) AU Housing Finance, Jan A U M I/WBC Consumer Sent, M ar, Index, (11.1) A U M I Consumer Inflation Expectat, M ar, %, (2.5) JP Leading / Coincident index CI, Jan, JP Domestic CGP I, Feb, m/y%ch, (-.1/.5) No. of own-occupiers, %, 2., (2.3) A U Dwelling commencements, QIV, q%ch, -6., (-6.8) A U M I Unemp. Expt., M ar, Index, (143.6) EU Trade balance Jan, bn, (7.5) JP Consumer confidence, Feb, Index, (4) Value of all loans, %, -2., (2.) JP Industrial production, Jan A U RBA Bulletin, QI 212 US CPI, Feb, m/y%ch, (.2/2.9); Core m/y%ch (.2/2.3) AU NAB Bus conf/cond, Feb, Index, (4/2) JP Capacity utilisation, Jan, m%ch, (3.1) A U M otor veh. sales, Feb, m/y%ch, (1.3/2.7) US Industrial production, Feb, m%ch, () NZ Food prices, Feb, m%ch, () JP Machine tool orders, Feb NZ Business PMI, Feb, Index, (5.5) US Capacity utilisation, Feb, %, (78.5) JP BoJ target rate, %, -.1, (.1) EU CPI, Feb EU ECB Monthly report US Uni. Of Michigan confidence, Mar, Index EU/GE ZEW survey (econ. sentiment), Mar, (-8.1/5.4.) EU Industrial production Jan, y%ch, (-2./-1.1) US Empire manufacturing, Mar, Index, (19.53) US FOMC rate decision, %, -¼, (.25) UK ILO unemployment rate (3mths), Jan, %, (8.4) US Producer price index Feb, m/y%ch, (.1/4.1) US Retail sales, Feb, m%ch, (.4) US Import price index, Feb, m/y%ch, (.3/7.1) US Business inventories, Jan, m%ch, (.4) US Current account balance, QIV, US$bn, (-11.3) AU RBA Gov. Stevens speaks in Hong Kong AU RBA Board Minutes, March A U DEWR skilled vacancies, Feb, m%ch, (-.6) A U RBA As. Gov Debelle speaks in Sydney CA CPI, Feb, m/y%ch, (.4/2.5) NZ PSI, Feb, Index, (53.6) AU RBA As.Gov Edey speaks in Sydney NZ Current account, QIV, % o f GDP, (-4.3) NZ GDP, QIV, q/y%ch, (.8/1.9) US New ho me sales, Feb, m%ch, (-2.2) EU Current account, Jan, bn, (2.) GE Producer prices, Feb, m/y%ch, (.6/3.4) NZ Credit card spending, Feb, m/y%ch, (.8/3.1) CA Retail sales, Jan, m%ch, (-.2) EU Construction output, Jan, m/y%ch, (.3/7.8) UK CPI, Feb, m/y%ch, (-.5/3.6); Core, y%ch, (2.6) UK Bank of England minutes JP Trade bal total/adj, Feb, bn, (-1475./612.8) US NAHB housing market index, Mar, (29) US Housing starts/building Permits, Feb, ', (699/676) US Existing home sales, Feb, m%ch, (4.3) EU Industrial new orders, Jan, y%ch, (-1.7) CA Wholesale sales, Jan, m%ch, (.9) EU/GE PM I services/manufacturing, M ar UK Retail sales, Feb, m/y%ch, (.9/2.) US Leading indicators, Feb, m%ch, (.4) NZ Trade balance, Feb AU RBA As.Gov Debelle speaks in Sydney A U RBA Financial Stability Review A U ABS Job vacancies, Feb, m%ch, (-3.3) A U RP Data house prices, Feb GE IFO - Business climate, M ar, Index, (19.6) UK Current account balance QIV, bn (-15.2) GE CPI, M ar NZ NBNZ Business confidence, M ar A U Private sector credit, Feb US Pending home sales, Feb UK GDP, QIV US Durable goods orders, Feb, m%ch, (3.) JP Retail sales, Feb NZ Building permits, Feb US Dallas Fed Index, Mar UK Total bus investment, QIV CA Teranet House Prices, Jan UK Net consumer credit, Feb JP Markit/JMMA PMI, Mar US S&P/Case-Shiller home price index, Jan US GDP, QIV JP CPI, Feb US Richmond Fed, Mar, Index JP Industrial production/construction Orders/Housing Starts, Feb GE Retail sales, Feb, m/y%ch UK GfK consumer confidence survey, M ar US Personal income/spending, Feb US PCE deflator/core, Feb US Uni. Of Michigan confidence, M ar Note: Figures in brackets represent previous result (if available). All information is preliminary and subject to revision. Chief Economist: Michael Blythe ph: Economist: James McIntyre:

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