FX

AUD – The US Administration’s moderating stance on Fed leadership and tariffs keeps open a (fragile) route to short-term relief for US equities, rates and the USD. China is reportedly considering exempting some US imports from its tariffs and a high level MOU-style agreement of understanding on trade is reportedly not far off with South Korea and Japan. Altogether the confrontational and escalatory tariff track is mostly in the rear view mirror.

That should put a floor under the heavily oversold USD which can be a headwind for AUD/USD. We can see AUD/USD spending some time above 0.6400 this week, but the 0.6461 interim highs from a couple weeks ago are likely not seriously challenged. On the downside, there should be support for AUD around 0.6335-50.

At the same time, the combative tariff backdrop also leaves the door wide open for AUD to claw back some of its dislocation on crosses. It has after all mostly adhered to its reputation as a liquid US-China trade war proxy. AUD/NZD has room to run towards 1.0800, AUD/EUR can trade through 0.5700, while AUD/JPY has scope to retake 93.00. We don't want to get too carried away though on upside potential for AUD-crosses. A comprehensive US-China trade deal and a meaningful decline in China tariffs is still many, many months away.

Either way, AUD/USD should eventually establish higher ranges, 0.6400-0.6600 initially, and higher beyond 3mths. We are still mindful about the potential for a larger medium term strategic portfolio rebalancing shift away from US assets. Tariff risks and escalation paths have peaked, but there's a scarring bitter aftertaste. Incoming data hard data should start to show tariff impacts soon. The Administration still has long term credibility and governance challenges, and the erosion of independent institutions still warrant a "risk premium" of sorts on US assets. The deterioration in the US' safe haven and exceptional branding is still visible in the correlation breakdown between the USD and US equity risk too - that will linger in the look-back calculation windows for FX-hedge ratios for many months to come.- RF

FX Majors - DXY is finding a fragile equilibrium in the 98-100 area as tariff risks moderate: China is reportedly considering exempting some US imports from its tariffs, a high level understanding of agreement around trade is in the works with Sth Korea and Japan, Bessent dared to state the obvious that China tariffs are unsustainable, while the USTR is reportedly working to a template setting common terms for negotiations with as many as six nations per week covering tariffs, NTBs, regulations, rules of origin, etc. Altogether the confrontational and escalatory tariff track is mostly in the rear view mirror.

DXY might see 101.0 against this backdrop, on a retracement, before the structural downtrend back towards 95.0 resumes, and in time, we suspect the low 90s, making for a complete 100% reversal of its post-Covid gains. The potential for a larger medium term strategic portfolio rebalancing shift away from US assets remains the key risk. There's a scarring bitter aftertaste even as the escalation path is complete. The Administration still has long term credibility, competence and governance challenges, and the erosion of independent institutions still warrant a "risk premium" of sorts on US assets. The correlation breakdown between the USD and US equity risk will linger in the look-back calculation windows for FX-hedge ratios for many months to come.

Consensus is braced for softer payrolls and ISM this week, but high frequency anecdotes - shipping container volumes & duties collected suggest non-negligible risks for a harder landing.

EUR: 1.1250/70 remains the key breakout level. Specs are heavily long by now, but long term Eurozone investors with stickier USD investments can be a key source of fresh EUR demand going forward, having built up a substantial unhedged USD overweight in recent years and the speed of EUR's ascent probably catching them out. USD/JPY could see 145.00 before weakness resumes. US-Japan trade discussions have not overly emphasised the weak yen and risk conditions have stabilised. - RF

NZD - NZD/USD’s April rally remains stalled around 0.6000. A range of 0.5850-0.6050 is plausible for the week ahead. Trump Administration headlines remain the dominant driver, with economic data taking a back seat. While the headlines remain uneven, keeping markets on edge, they have become less combative in tone, supporting risk currencies such as the NZD and AUD. The AUD/NZD cross has potential to rise further during the week ahead, to 1.0800+, barring a deterioration in sentiment. It is technically stretched and due at least a corrective bounce. In addition, the AUD usually outperforms on favourable news on China. - IS

Rates

US Rates - The sense that trade tensions could undergo an extended period of de-escalation, combined with UST supportive comments from Treasury Secretary Bessent on the weekend, should promote more “normal” market conditions as we begin the week. After trading to the bottom of a 20bp weekly range (4.23-4.43%), the question is how much lower 10yr yields can fall? If calmer conditions prevail, as we tentatively expect, then a move to broader range lows around the 4.10% is certainly possible, if supported by important data (GDP, ECI, ISMs and Payrolls) on the agenda this week. While risk rewards around each could be blindsided by any renewed erratic White House behaviour, under normal circumstances we would expect bonds to rally more on weaker growth outcomes, than the opposite.

Outright: The market is currently factoring a Fed Funds target range of 3.25-3.5% by early 2026. That implies a spread to the 10yr yield of around 90-100bps, which historically would be an appropriate spread as we approach the beginning of an easing cycle, implying a slowing of the recent rally. But we do not live in normal times and there are other significant influences at play which makes traditional “fair value” more difficult to assess. For one, the market continues to grapple with Fed policy under stagflation. Recent comments from Powell suggest that inflation will remain the key focus, which could slow rate cuts. In addition, fears of a bond market dislocation given the administrations arbitrary and capricious policy making will not quickly dissipate, which raises the question as to whether the recalibration of the UST risk premia has further to run. While the push higher has reversed in recent sessions, it could easily begin climbing again over coming weeks, especially as it remains below long term average levels. So there is a lot to consider, some with near term impacts and others a slow burn over the medium term. All of that perhaps makes forecasting yield levels a meaningless task at present, although our sense is that the recent range for US 10yr yields is likely to remain in place, centering on the 4.4-4.5% level.

Curve: Having moved back from its steepest levels, we suspect that the curve is likely to consolidate around current levels. Further near term flattening would be related to a paring back of Fed expectations, however that would be in the form of a “tweak” to the current outlook, rather than represent a major curve trend reversal. Hence, from current levels we would fade any material flattening, with a view that the 2-10yr curve will eventually move back toward the 65-75bp range.

10yr Spread to Bund: The rally in USTs has seen the US-DE 10yr spread has 20bp below its recent peak. We will wait for the current outright volatility to settle down before re-assessing where to from here, however our previous confidence that this is setting up for a narrowing opportunity is now seriously diminished by the ongoing debate about whether the US has lost its exorbitant privilege. - DM

AU Rates – Wednesday’s quarterly CPI will be the key domestic risk event this week, with only a shock upside outcome likely to significantly alter market pricing for the May 20 RBA Board meeting and the easing cycle beyond that. The market continues to ascribe a small chance of the RBA cutting by more than 25bp in May. We see a 25bp cut as almost a done deal, but a larger move remains unlikely. Even so, we recognise that the current forward cash profile reflects global growth risks as much as it does domestic considerations and as such we would not expect a significant re-calibration of the “4 and a bit” rate cuts factored-in through year end even if the CPI clouds the near term picture.

Outright: Last week saw far narrower ranges, reflecting less volatility than the extremes of the previous fortnight. 3yr futures now appear to be settling within a 96.60 – 96.80 range. We would be better buyers on dips but would not assign much risk to outright positions. 10yr futures have continued to rally, as curve flattening globally has been supportive. In line with our view of a slowdown in the UST rally in coming days, we are also looking for a consolidation domestically. A tentative 1-2 week range would be 95.70-95.90.

Curve: The curve has retraced around 28bps of its recent rapid steepening impulse and the question is whether that will extend in coming days. The main driver of a further flattener will be a revised RBA policy track, while a renewed steepener would be driven by a rise in the US risk premia. We suspect the latter is a more medium term influence, although any ongoing de-escalation of the tariff war will see further near term flattening as the curve moves into a consolidation phase. We continue to expect the AU curve to flatten on a relative basis versus the US.

Swap Spreads: 10yr EFP is back around -7.5bps in the middle of a -15bp to -5bp range. There is clearly a major directional component of this price action, however we remain of the view that spreads on average will tend toward the narrower end of the range. We outlined a comprehensive swap view in the A$ Rates Weekly a week ago.

Semi Spreads: Semi spreads have performed very well in recent weeks, narrowing against both bond and swap and outperforming other credit comparators. That is a reflection of a willingness to invest in Australia given its stable institutional environment and high reward-for-yield characteristics. With the AU-US bond spread inverse, it has also likely attracted further demand to the sector. The question this week is whether lower outright yields and narrow spreads, will lead to a supply driven underperformance? That will depend on how much global capital markets open up and there will be a particular focus on current valuations should QTC launch its 10yr EUR deal.

10yr Spread to UST: AU bonds have given up some of their recent outperformance as USTs rallied. While that is a normal spread performance, we continue to note that AU bonds have had a good performance during the global ructions of recent weeks. That is just another manifestation of the shifting world order, with USTs not representing the same risk characteristics as in the past, while AU is transforming into a safer net saver nation. -DM

NZ Rates - The NZ 2yr swap rate remains slightly above tentative support at 3.02%. Offshore economic risks continue to dominate, but NZ monthly business confidence this week will be watched. OIS pricing has stabilised at 3 more 25bp cuts in this cycle, and the chances of a 50-bp cut along the way have receded.

The 2-10yr swap curve is following the US curve, but may have peaked at 105bp (the mid-April, and a multi-year, high). Flatteners look technically appealing, but the NZ economic outlook will remain highly uncertain while trade wars persist.

NZGB i-spreads have fluctuated recently below the record highs set in December. The 2035 i-spread opened today at 50bp (vs the record high of 65bp), and should fall slightly further, helped by last week’s NZDM announcement reducing weekly tender supply in May ($500m to $450m). NZDM was well placed to do this given it will end FY25 $2.5bn ahead of the $40bn target, so that the lower tender pace could be extended to June and even beyond.

NZGB-UST 10yr spreads remain rangebound, although retain downside risks given the erosion of the UST safe-haven identity.– IS

Funding, basis, and liability management.

Markets are still healing, and an example of this was seeing the USD, US equities and bonds all rally on the Friday session, with the rates curve also flattening after a fairly brutal move. Rates vol has continued to ease, with the green light/red light tariff news and more soothing words from US Treasury Secretary Bessent. Global markets will continue to be influenced by the US market, with the idiosyncrasies of local market news playing out with local data.

For rates hedgers, levels have moved well and truly into the sweet zone we targeted since the end of last year, and so there should be a level of comfort in coverage. Forward curves are flatter, and the floating to fixed rate curve remains quite inverse at a mid-market level. The dichotomy is a weaker global backdrop would suggest further rate cuts, as do the poor levels of sentiment and confidence that have come about due to the policy confusion. A backdrop of producers already raising their prices for goods to the USA and a sharp drop in container demand add to this.

Locally, the RBA seems to be resolute that the need for the pace of rate cuts implied by market moves is noise and unnecessary. We tend to agree with the latter view. That said, the release of CPI data for both the month and quarter this week, which are expected to see CPI in the zone, has green lighted the May RBA rate cut, which is already priced for such an event, as well as holding pricing suggesting a bigger cut.

In the specific funding markets, BOB spreads, which had popped higher in the moment of market problems are retracing their moves and while high are at a neutral level for liability managers. For choice, receiving them is the stronger view, but the moves are likely to be smaller as market participants will still want a level of optionality around risk events. Thus, a single digit target is possible, but ambitious for now.

FX/OIS basis is still a little higher than our expectations but has been easing in the last few days. We would expect term basis to fall from here.

Cross currency basis levels in A$ (BBSW/SOFR) are displaying an unusual bid but remain at normal levels. The curve remains lower and quite flat but has bounced from the offered levels seen mid-month as market action kicked off. We discuss the collateral shifts at the time but would make the observation that the AUD/USD has bounced here and so these flows will have stopped. For super funds, global equities are still down on the month, reducing hedges, however the volatility of recent weeks, FX, equities, bonds, hedges, is likely to result in a tighter framework around hedging needs. Depending on how markets finish the month, the normal equity related hedging would be extremely low. The basis is elevated, though notably spot 5s/10s has dropped from 5.6bp mid-month to 4.4bp, the lowest level since Oct. If capital markets are operating again, we may see the QTC 10-year EUR deal come to market, which should push the curve a little steeper.

Looking at broader data on funding, the Fed’s USD swap lines appear not to have been used in the recent market maelstrom. Helpful, in the sense that funding did not go awry, but as we wrote at the time, the contemporaneous moves in Xccy basis- like JPY front break, EUR front break and other majors did not signal a scramble for USD. Again, as written, that was very notable and has been borne out in the data. This remains the case and as such AUD is the only market, where funding moves have gone this way. -MW

Commodities

Crude:

The merest hint of ‘secondary sanctions’ on Russia to try to force a ceasefire agreement in its Ukraine war should be enough to keep Brent probing up into the $68 to $70 region near term. However, we tend to see that as something of a distraction to the main event which is next week’s May 5 OPEC+ meeting where the group will decide on June production levels. Having tripled the pace of increase of the return of May barrels, Reuters last week reported that OPEC+ is considering another accelerated output hike in June as another warning for Kazakhstan to meet its overproduction commitments. This followed Kazakhstan’s energy minister telling Reuters that “his country will prioritise national interests over those of OPEC+ when deciding its oil output levels”. We stick to our view that the front end of the curve will eventually be pulled lower, once we see signs of rising production and demand destruction coming through. And we note that our measure of global crude inventory is already at the highest level seen since July last year. Hence the fact that we see Brent back into the $60/65 range as we move through Q2 into Q3.

Metals:

The surge in Comex and collapse in ShFE copper inventory tells an important story about how potential tariffs are impacting global shipments away from China, helping to support copper prices. ShFE copper inventory has fallen 56% from its March peak while Comex inventory has surged 42% so far this year as hundreds of thousands of tons are being shipped to the US driven by US purchasing managers rushing to secure supplies before the section 232 report is concluded and we likely see 25% tariffs on copper imports. That’s helped copper break every moving average we monitor, leaving it looking great technically. However, fundamentally it looks extremely unattractive to us at these levels. Codelco reported a modest 0.3% rise in its copper production in Q1 to 324kt. However, that’s actually a very good number given heavy rains and blackouts in February which would have impacted circa 10kt. The firm is guiding production of between 1.37 and 1.4mt for the year versus 1.33mt last year, with new projects starting to come online. Wires are also reporting that the Panamanian President is mulling restart options for the massive Cobre Panama copper mine, which closed in December 2023. With end user demand being destroyed by tariffs and trade wars, we stick to the view that it’s very hard to see copper sustaining much above $9,300.

Meanwhile, Aluminium got a boost from news that US President Trump is reportedly planning an exemption for automakers for some tariffs at the same time as de-escalating the trade war with China. However, this appears to be more talk with little action hence the idea that aluminium should remain capped by $2,500, unless of course we do actually see major de-escalation taking place.

Iron Ore:

We stick to the view that iron ore is well supported above $95 for now, but a drop below $90 and beyond is coming in the second half. If we do see ‘unilateral tariff de-escalation’ between the US and China, then we could extend towards $105. However, the mood in the Chinese steel industry is deteriorating as trade protection actions in EM markets to protect against Chinese dumping become more common. Bloomberg Intelligence estimates that about 50% of Chinese steel exports are now exposed to tariffs. In addition, Chinese property sales remained close to 15yr lows in March, while the price of rebar is close to 8yr lows. With the domestic steel industry facing another wave of rationalisation this year, falling steel prices and rising iron ore prices mean that steel mill profitability is at some of the lowest levels seen in a decade. With iron ore supply out of Africa due to start hitting markets late this year and into next, we remain of the view that iron ore prices will fall below $90 and beyond later in the year. - RR

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