The Australian economy is picking up under reopening, and a falling saving rate. The likelihood of borders staying closed through most of 2021 limits the output gap damage to an extent, such that inflation doesn’t fall entirely off the map. Further, the unemployment rate is likely to finish 2021 with a 6-handle. This means there is life in the cyclical outlook yet. The RBA’s QE program and new policy guidance framework therefore exert a genuine constraint on front-end rates, and have something to ‘push against’, generating significant influence on local curve shape. This is a clear point of difference to 2020, where global market correlations and the local deleveraging impulse were dominant. In that context, RBA balance sheet expansion (and for that matter, issuance trends), explained very little of the performance in term yields, beyond their effect on the very front-end. Controlling front-end yields under YCC was sufficient to anchor the remainder of the curve under the same betas that prevailed pre-COVID.

 Things are changing as we move into 2021. In November, the RBA started a more quantity-centric purchase program, with the intent of catching up to other central banks in balance sheet expansion. The leadership is averse to negative rates, and to Yield Curve Control (YCC) tenor extension, so incremental easing will continue to be deployed via explicit liquidity injection (i.e. quantity targets). A$100bn of RBA QE absorbs all AOFM net issuance for the remainder of the fiscal year, and other things equal, would leave banks at the shortest levels since 2016. Keep a strategic bias to OW ACGB 10Y bonds vs UST 10Y notes, and vs the NZGB 10Y sector, particularly in a rising global yield backdrop.

 We also expect a steeper swap spread curve into 2021; position for a steeper 3s/10s EFP box, a flatter 2s/5s ACGB curve, and cheaper belly in 2s/5s/10s swap fly. We expect much stronger transmission from incremental RBA asset purchases and Term Funding Facility (TFF) use into Exchange Settlement Accounts (ESAs), now that fiscal withdrawal has ceased. Surplus ESAs should swell to over A$200bn by June, and the RBA’s balance sheet should increase from 15% of GDP to 24%.