As highlighted in Figure 1, the recent rally in the AU 1y swap rate 1y forward (AU 1y1y) appears to have been driven by a collapse in our Australian data surprise index (DSI).
A closer look at Figure 1, however, raises questions about the reliability of this relationship. Indeed, the 60d rolling correlation coefficient has oscillated between -0.8 and 0.8 over the past couple of years.
Figure 1: Australian data surprise index vs 20d change in AU 1y1y
Source: Bloomberg, Barclays Capital
A more reliable relationship, with a 60d correlation coefficient that is always positive, is the one between the 20d change in Australia’s commodity futures index and the AU 1y1y.
As Figure 2 highlights, however, the relationship is better than the one between the DSI and the AU 1y1y, but far from perfect. That said, divergences between the two series tend to relatively short lived.
Figure 2: 20d change in commodity futures index vs 20d change in AU 1y1y
Source: Bloomberg, Barclays Capital
The tendency of the commodity futures index and the AU 1y1y to mean revert can be seen more clearly using z-scores (Figure 3). To that end, movements in the commodity futures index and the AU 1y1y have diverged significantly over recently.
Figure 3: 40d z-score: commodity futures index vs AU 1y1y
Source: Bloomberg, Barclays Capital
Indeed, if we look at the difference between the two z-scores , it is fairly clear that the current divergence between movements in the commodity futures index and the AU 1y1y is close to an extreme (Figure 4).
Figure 4: 40d z-score differential: commodity futures index less AU 1y1y
Source: Bloomberg, Barclays Capital
Given that, the obvious question to ask is whether we can profit from the current divergence?
Thankfully, a simple back-test of large z-score differentials suggests that it is profitable to position for a rise in the AU 1y1y (currently 3.69%) over the coming weeks.
Positioning for both a lower commodity future index and and a higher AU 1y1y would be ideal. That said, following the simple trading rules below for the AU 1y1y alone, based on our analysis, there is a 73% probability that the position will be profitable, with an expected pay-off of 23bp:
- Pay AU 1y1y if z-score differential > 2 standard deviations (current level qualifies);
- Take profit when the z-score differential < 1 standard deviation; and
- Trailing stop of 10bp.
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