Diverging Monetary Policy Expectations Narrow Australia-US Bond Spread, Australian Yields Set to Fall Below US Levels for First Time in Over a Year

Diverging monetary policy outlooks between Australia and the United States are set to push Australian benchmark bond yields below their US counterparts for the first time in more than a year. Strategists argue that Australia’s relative bond outperformance can extend until late 2026, as markets widely price an imminent end to the Reserve Bank of Australia’s (RBA) tightening cycle, while the US Federal Reserve still has ample room for further rate hikes.

The spread between Australian and US 10-year Treasury yields has narrowed sharply to around 12 basis points, hovering near the lowest level since September 2025. Leading financial institutions have offered upbeat projections for the spread’s trajectory. Barrenjoey Markets and Westpac expect the two yields to converge in the coming months, while National Australia Bank forecasts the spread could even turn negative.

Australian bonds have grown increasingly attractive amid supportive fundamentals. Recent data showed cooling Australian inflation in August. Meanwhile, RBA Governor Michele Bullock signaled dovish sentiment, stating that she is “hopeful” the four rate hikes delivered this year will be sufficient to curb price pressures, leading markets to conclude that the RBA’s tightening cycle is nearly complete. Additionally, amid a global bond selloff, Australia’s AAA credit rating and improving fiscal position have helped cap upward pressure on long-term bond yields, endowing Australian bonds with strong resilience.

Bond performance diverged sharply between the two countries in September. The benchmark index tracking Australian government bonds fell 1%, compared with a 2.2% drop in the index measuring US Treasury returns, highlighting Australia’s clear relative advantage.

In contrast, US Treasuries face sustained heavy selling pressure. Bolstered by robust economic growth and lingering inflation risks, markets expect the Fed to deliver additional rate hikes after resuming tightening in 2023. Mounting concerns over US debt sustainability driven by massive government borrowing, as well as large-scale corporate bond issuances by AI-focused tech giants, have further intensified the US bond selloff, pushing the 10-year US Treasury yield to its highest level since 2002.

Market pricing fully reflects the divergent monetary policy trajectories. Swap rates indicate traders expect three 25-basis-point Fed rate hikes over the next 12 months, while only one rate hike is priced in for Australia.

Nevertheless, further narrowing of the Australia-US yield spread will likely be gradual and faces uncertainties. Australian bond prices remain highly sensitive to US Treasury movements, which limits the scope for spread compression. Moreover, stronger-than-expected Australian inflation or employment data due for release this month could revive market expectations for additional RBA tightening, disrupting current dovish consensus and delaying the spread inversion. While the monetary policy divergence between Australia and the US remains intact, the inversion of their yield spread will unfold slowly.

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