FX

US$ - A notable shift in messaging this week from a couple of hawks on the Board of Governors keeps the soft USD backdrop in place. US Oct PCE reinforced the message that encouraging disinflation trends are unfolding too, while Powell tonight could well echo Waller and Bowman’s message. China’s Nov PMIs were underwhelming, aiding USD, but a more supportive policy backdrop is being introduced. With Eurozone activity surveys troughing, soft USD atmospherics look set to stay in place. The Nov FOMC minutes showed staff PCE projections for end-2023 coming in lower, a pointer to probable downward revisions in the mid-Dec FOMC projections. That could bleed into 2024 and nudge several 2024 dots lower. We have a hard time seeing DXY much above 104.50-105.00 and DXY likely settles into the 101-102 zone into year’s end. Macro FX Trade Ideas for the majors: We are long EUR/USD at 1.0895, targeting 1.1200, with a stop at 1.0820.

A$ - The Aussie has stalled around 0.6600 as US dollar price action has finally become more two-way and the AU CPI/RBNZ combination has nudged the A$ down the dollar bloc pecking order at least short term. But the 45% chance of another RBA hike still stands out among major central banks. Softer US data and a more dovish tone from key Fed officials remain a weight on the US dollar and look to be key to the AUD/USD up trend, albeit with Powell comments looming. But the ultimate scale of Aussie gains in coming weeks seems likely to be constrained, given the cool investor response to China’s fiscal stimulus measures and ongoing concern over property sector stress. Still, with USD/CNY fixings (lows since June) reinforcing a broad weight on USD/Asia, potential for the FOMC to tweak its language and forecasts in December and the sustained improvement in the Aussie’s yield support, AUD should regroup for a run at 0.6723 (1 August high). Our preference on cross rates remains long AUD/CAD from 0.8955, targeting 0.92 multi-week, with CAD held back by the softer US growth pulse and oil prices likely to trade sideways to lower.

NZ$ – We remain bullish for the week ahead, although the day ahead risks an extension of last night’s corrective pullback to the 0.6050-0.6100 area, Fed chair Powell’s discussion tonight the main risk event. Tactically, we are buyers of dips, at 0.6060, targeting 0.6250, with a stop loss at 0.6000. While the month-old rally, driven by US developments, is getting ripe, the recent hawkish surprise from the RBNZ provides a fresh bullish factor. Important local data during the month ahead includes migration (12th), GDP (14th), and CPI (24 Jan).

Rates

US Rates: After such a strong bullish impulse over the past few weeks, it is probably no surprise that USTs had a slight corrective session, perhaps led by profit-taking around month end. With around 120bp of cuts factored-in for 2024, valuations are clearly extended, and neither the PCE data, nor the Fedspeak (Daly, Williams) overnight, was sufficient to extend the rally much further. With that in mind, the tone of Powell’s message on Friday should go far to set the near term market mood. In our view, a period of consolidation is highly likely. It has been our view that, from a valuation perspective, 10yr bond yields are expensive at current levels, however we need to respect price action, and sentiment is such that dips are likely to be bought into on the medium-term yield-seeking, long duration trade, setting up for 2024. So that will cap the upside for yields, although we favour a move back to 4.5% in coming days.

AU Rates: There is now less than 10bp of hike risk factored-in for the March meeting. At the beginning of the week, the terminal rate was 4.55% by May. So that is a significant change from both the level and the timing perspective. Given the global backdrop, in which a significant Fed easing cycle is factored-in and the debate is about when, not if, it will being in 2024, the domestic market is clearly suggesting that the odds of a further RBA hike are diminishing and the window for delivering one is narrowing. So, we need to ask whether this is an over-reaction, or whether the market might be pre-empting a shift in messaging from the RBA? We will know more after Tuesday’s Board meeting. For now, though, we feel that the re-pricing has gone far enough, and we maintain our Dec-Feb OIS steepeners. And we would expect a near term bearish impulse across the term structure. Our preference is for curve flatteners, especially on a relative basis to other markets. The AU-US spread has widened on the US-led sell-off but it is at levels that we think are attractive and we recommend investors add to narrowing positions at current levels. In semis, yesterday’s re-opening of the NSW 2036 benchmark went well and is likely to be the last major issuance for the year as the “blackouts” ahead of half-year budget updates begin next week. That should be supportive of semi-bond spreads, even though they remain near the lower end of recent ranges as support arises from the yield seeking global bond outlook.

The Commonwealth’s decision to move to a 50:50 funding rate with the states from infrastructure remains a key discussion point, although a lot of the commentary from the states is largely posturing at present and should not have much impact on the near term issuance profile. The real question, however, is whether the states will fund these projects themselves anyway, hence needing to raise most of the cash, or whether some projects will need to be scrapped given the need for fiscal repair. We expect the latter. Indeed, we see the review as largely tightening the need to provide a strong business case for any project to gain funding and that should be a good thing overall. It should remove politically-based decisions and “vanity projects” from the equation. Of course, the stronger the business/nation building case, the more likely it would be that the Commonwealth will provide more than the minimum support, as the review did not rule out moving away from the 50:50 model should it be worthwhile to do so. All up, we continue to believe the outcome of the review will be net positive for semi spreads from a supply perspective.

NZ Rates - The corrective bounce in NZ short end swap rates remains intact, although it has been mostly driven by offshore events. The RBNZ’s hawkish surprise has not shifted OIS pricing much, markets seemingly skeptical the RBNZ could deliver another hike. February meeting OIS remains underpriced at 5.52% (effective), and still offers appealing risk-reward characteristics (yesterday we paid that date at 5.51% effective). We expect OIS pricing to be volatile over the major NZ data events, and markets to price at least a few more bp into February. Yesterday’s NZGB tender was solid overall, but mostly due to demand for the shorter 2030 line.

Funding, basis and liability management

After a solid pullback in term rates which filtered through to OIS pricing, the front end of the curve is likely to find a bottoming out over coming days, as markets consolidate. BBSW itself should be steady, but runs the risk of modestly higher sets.

BBSW/OIS has not been discussed in this forum for about a week, but that’s really as it played out with a tight spread as we had expected and now sits around recent lows. A risk on it would be a small widening from now as we approach the calendar year end.

As yesterday represented the month end, we saw further extension of FX/OIS basis lower, particularly in the 1 month tenor. This was a move we highlighted from early in November as asset markets rallied. The strong gains in equity, fixed income and credit see Australian funds bring swap back foreign earnings and valuations as a hedge and November was a large month. This was also despite the rally in the A$ which took some of the move off.

Keep an eye on this now that the month end has passed, and we get some potential hoarding of cash from the US investment banks who will face FY end in a few weeks’ time. There could be some tightness in A$ to ensure funding for repo books or balance sheets more broadly.

For corporate hedgers, the inversion, albeit small, of floating to fixed rate sits as an opportunity, as does the outright level of swap rates. Topping up hedges, given the fall in rates is something to look at. We’d expect that there may be some element of hedging looking at longer tenors, given the flatter curve. For investors, we hold a trade idea in a 3 month forward 2s/5s curve to trade flatter, which it indeed has done. Flipping this around for corporates, we are of the view the inversion will continue, albeit at a slower pace than what we have seen so far.

What are we thinking on the OPEC+ announcement?

We noted yesterday that “if we don’t see further cuts in crude production quotas from OPEC+, we could see in the region of a further $10 slide in crude prices in coming days and weeks”. Well OPEC+ delivered, but it did so with one hand tied behind its back! How so?

Well the initial statement merely “reaffirmed the continued commitment of the Participating Countries in the Declaration of Cooperation (DoC) to ensure a stable and balanced oil market” with no detail of cuts. It was left to each country to confirm their cuts, followed by a subsequent statement confirming the “announcement of several OPEC+ countries of additional voluntary cuts to the total of 2.2 million barrels per day, aimed at supporting the stability and balance of oil markets”.

We calculate 900kbpd of additional cuts with Saudi Arabia extending its cuts through to Q1 2024 and Russia deepening its voluntary cuts to 0.5mbpd from 0.3mbpd of crude and 0.2mbpd of products. However, the lack of a simple summary table in the second statement plus news that Angola had rejected its cut and would produce 70kbpd over its quota added to the market scepticism and Brent is closing out the volatile session close to the day’s lows, having rejected a run up towards $85.

Importantly, the statement does note that “these voluntary cuts will be returned gradually subject to market conditions,” suggesting that the main impact is set to be felt in Q1 2024. However, ex-Angola, these are real cuts. Outside of the way the agreement was presented, they should go a long way to help prevent crude builds into Q1 and remove some of the downside risk.

However, with Russia ending its liquids export ban, higher US NGL supply, likely warmer winter temperatures due to El Nino weather conditions, and the risk we see lower refinery runs driving liquids stock builds through Q2 2024 and Q3 2024 given the lagged impact of monetary policy tightening and greater vehicle efficiency, we stick to the view that risks remain to the downside for crude markets.

Bottom line, we are impressed that yet again OPEC+ has been able to deliver, just not the way that they did it.

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