FX

AUD – Noting the underwhelming price action in AUD the last 24hrs, especially over the RBA yesterday, but not inclined to read too much into it. Admittedly another overnight leg lower in Brent (-4.6%) and US yields helped lift AUD off its lows, but even so, AUD/USD is at best net-net unchanged on the last 24hrs. We would have assumed that a test of the early week gap highs ≈0.7090 might have been in order. Still, AUD should find support into 0.7045 for now.

1-3wks: Central banks take the wheel. Expected range: 0.6980-0.7180. While AUD traded uninspired over the RBA, their messaging should nevertheless help put a floor under local pricing for RBA rate hikes for now. Then there's Warsh's maiden press conference. Removal of the implicit easing bias language and a hawkish migration to the dots are taken as a given. Warsh certainly inherits an inflationary backdrop and a stabilising labour market. But his "AI-is-disinflationary" credentials, lingering questions about Trump loyalty, and preference for a trimmed CPI target all raise questions about where he sits on the hawk-dove spectrum. The risk has to be that he delivers a more even-handed tone than positioning assumes. We think AUD has a fighting chance of finding its centre of gravity on the higher side of our expected 1-3wk range, i.e. >0.7100.

3-12wk outlook: Expected range stays wide, 0.6800-0.7400. The US-Iran MOU structure - sequenced, conditions-based, nuclear specifics deferred to future negotiations, frozen Iran fund release still ambiguous & Israel being outside the deal collectively means that an MOU doesn't collapse this wide range. The tails are still thick and all we have done is price relief, not resolution. On US rates, lower oil is disinflationary and a potential trigger for AU-US spread re-widening, but only if Warsh notes the encouraging move in oil. A Fed that holds the line regardless keeps the AUD spread-compression headwind for AUD intact, even in a genuinely improving US-Iran backdrop. All told though, with the local growth impulse softening, and a US exceptionalism 2.0 narrative gaining ground, AUD/USD's centre of gravity in this window is hard to read clearly right now, even as the week ahead RBA/Fed could resolve constructively for AUD.

12wks+: Structural AUD bullishness reasserts, albeit on a slower and much less potent timeline. AUD's still high carry, clean fiscal metrics, deep commodity endowments, AI/energy capex credentials leave it well positioned. USD impairment narrative is directionally intact, but sidelined. The US-Iran war thickened AUD's tails and AU super funds face no urgency to lift FX hedges for now, but that can change - Trump could easily land more shocks that upset the safe-haven hedge effectiveness of the USD. 0.75 by 2H26 still the call, but confidence intervals much wider. Monitoring domestic conditions - they have cooled, which caps AUD/crosses.- RF

NZD - NZD/USD 1 week outlook: neutral; 3 month outlook: neutral

NZD/USD has been stuck in the low 0.58s for the past two weeks. That area is now established as major support, and we are watching for either a break below or a bounce higher to set multi-week direction. The downside case is that NZ economic momentum remains weak and market pricing for OCR hikes has scope for further paring. The upside case probably requires an enduring peace agreement, which would weaken the USD and lift NZ economic confidence. We assign a slightly higher probability to the downside scenario for the near term. Tonight’s FOMC is clearly a major risk event. NZ Q1 GDP data on Thursday will read for starting point evidence.

For the quarter ahead, we retain a neutral bias, pending an enduring resolution of the Iran war. A positive outcome could boost the NZD towards the 0.6000 area, while a breakdown could cause a decline to 0.5700.- IS

Rates

US Rates –Yields across the curve have continued to fall on the improved outlook in the Persian Gulf, although the pace of declines has slowed somewhat. Yields will continue to drift lower while the current optimism remains, however the question is whether an extended bullish directional shift can eventuate and be sustained? We would not expect the positive impulse to push beyond a further 10-15bp at the 10yr maturity. A lot will depend on what the new “normal” looks like after a deal is agreed. Questions include, how much friction will remain in the Strait, including any ongoing tolls. How reliable will either sides promises be? Will a surge in East-West transit be matched by tankers going the other way? And perhaps most importantly how quickly can oil production and supply ramp back up, including repairs to crucial infrastructure? Those questions suggest that there will likely be a pause after the initial euphoria as the inherent medium term risks are re-assessed.

Beyond the issues in Western Asia, this week’s FOMC meeting will garner interest not only for the evolution in the Fed’s thinking on inflation, but because it is Warsh’s first meeting as Chairman. The tones he strikes around the balance of risks will be particularly interesting.

Outright: We certainly expect the tactical 10yr yield trading range to move lower but even then we would expect the lower bound of that range to be around 4.20-4.25%. Bond markets will obviously maintain some correlation with oil prices and there is little reason to expect the latter to revert to a pre-war level near term. Even so, the agreement is positive for the bond market and as such we will temper our short duration / sell rallies bias until the initial market response provides more trade signals.

Curve: The recent re-pricing of Fed risks, not surprisingly, saw the UST curve flatten but that has slowed and reversed as some of the markets worst fears have been salved. In line with that, we suspect the curve will steepen further on a positive re-calibration of Fed risks, which fits with our oft-stated steepening bias. Medium term, the mixture of inflation risks and long term issuance trends will keep the curve steeper than it otherwise would have been in previous cycles.

10yr Spread to Bund: The spread remains around150bps where we suspect it will average in coming weeks. Global investor perceptions of US risks have clearly shifted for the worse. - DM

AU Rates – The outcome of yesterday’s June MPB meeting and the language Governor’s Statement was largely as the market expected. They noted that “inflation is still too high” and that “the unemployment rate was higher than expected in April, but other measures of labour market conditions have been more resilient”. That is the tone expected for a “hawkish hold”, with the last sentence suggesting that a further hike was debated and live for future meetings “if needed”. Our economists note that adding that language to their the usual remark about doing what is needed to achieve its policy goals is unusual for an RBA statement, and a stronger steer than usual. It suggests that the MPB wanted to hose down recent speculation that they are done hiking rates.

There is now around a 50% chance of a further hike by year end. That is likely to remain the central case as the market debates inflation vs growth trade-offs. While that is logical given the tighenings already delivered, as well as the softer monthly inflation print, higher unemployment than expected and depressed confidence reports for business and consumers, we continue to caution against factoring the end of the hike cycle too early. The RBA is still facing a difficult inflation environment, so a long period on hold while maintaining a hike bias is the most bullish scenario that the market should price-in. And that is what is currently in the price, so further rallies should be faded.

Outright: We remain better sellers into strength. However, that directional bias is held within the context of a broader range trade, rather than a strong bearish trend exerting itself. That is because, at this stage of the RBA’s tightening cycle, further rate hikes would increasingly slow yield rises across the term structure and will encourage investors to pick up yield when available. For now, we are tactically neutral at current levels and recommend trading the following ranges with a sell-side bias: YM1 95.45 –95.70; XM1 95.10 – 95.30.

Curve: The curve has steepened as RBA hike pricing has abated. However we think the shift should slow in coming days. Beyond the near term policy driver, in our view, medium term, curve shape will also be heavily influenced by the expectation that any sustained normalisation in risk conditions should see global investor demand comes back into focus and yield enhancement trades will support a relatively flatter curve over the long term. The biggest risk is a surge in global long end yields beyond the levels traded over recent months, but that is not a near term concern.

Swap Spreads: We see EFPs as largely directional at the moment but with a higher beta to bond rallies (and hence widening impulses) than the opposite. For now we expect both benchmark EFP spreads to test the upside of recent range but for receive-side sort to be attracted at those levels.

Semi Spreads: The semi sector will be supported by a “risk on” development in global markets. For those looking at “end of cycle” trades, the extra yield and carry characteristics around the 3-5yr maturities will be attractive, adding to support. Ahead of the NSW and QLD budgets next Tuesday, supply will be limited, so expect spreads to remain tight and, beyond that, we continue to believe that any material spread widening will be capped and any such moves should be viewed as an opportunity.

10yr Spread to UST: Regular readers would be aware that we have held narrowers since 68bps. The spread is now back at 39bps, so we maintain our position for now, with a target of 30bp before reducing risk. - DM

NZ Rates - NZ 2yr swap 1 week outlook: lower; 3 months: higher.

The NZ 2yr swap rate has accelerated its month-old decline to 3.26%, down from around 3.70% in mid-May. It retains potential to fall further towards yield support in the 3.15%-3.20% area during the month ahead.

The peace agreement has catalysed a fall in shore yields, spilling over to NZ. But local economic data remains weak, inspiring fresh receiving. Our economists revised their CPI forecast slightly lower in response to the fall in oil prices and slightly softer CPI partials yesterday.

OIS pricing for the next RBNZ meeting on 8 July continues to be pared, now implying a 70% chance of an OCR hike (was 90% last week), and around two hikes in total priced by year end. Our economists expect three hikes this year, but starting in September.

The yield curve’s flattening trend since the peak in late December has stalled amid the repricing of RBNZ hikes, the 2-10yr swap up from the cycle low of 69bp in early June to 80bp (but down from the cycle high of 120bp in December). We expect further flattening during the year ahead with proximity and during the RBNZ’s tightening cycle, the 2-10yr swap potentially to 50bp.

The downward trend in NZGB 10yr i-spreads has also stalled, consistent with the recent decline in outright yields, although shorter maturities remain in demand for attractive carry and roll. Medium term, the prospect for higher yields as the RBNZ tightens should see NZGBs outperform swaps, helped also by a constructive issuance projection.– IS

Funding, basis, and liability management.

With a deal between the warring parties finally appearing to reach its dénouement, markets have focussed on the aftermath, and relief trade. Oil continues to fall and has taken yields lower with it as inflation concerns are moved aside. The FOMC starts a meeting with its new Chair Kevin Warsh, while the RBA left rates unchanged yesterday. Westpac’s views is they remain slightly hawkish and are not ruling out a further move if warranted.

The year ended OIS pricing sits at 4.48, well down on recent peaks and lower over the week. Keep an eye on pricing, as it may drop further.

The term rate curve dropped last week and will be lower again today post the RBA meeting, and this is helpful for corporate hedgers who missed out on adding cover before the sell-off in rates. Around the peak of yields we were suggesting a hold and a wait for a 15-20bp pullback before committing to action. The rates have dropped further than this, which gives hedgers a much better opportunity cost-wise to hedge. It is more likely that hedging has been done (our recent flow data suggests the same) and so corporates might pause for the moment if considering this. Watch for rates curve steepening with the background news.

In Xccy basis, Alberta printed A$1.25bn 10s on Wednesday and was followed up by Ontario with A$1bn. The 5s/10s/15s BBSW/SOFR fly has dropped to its lowest levels again in recent months, under 1bp as these deals get done. This is a new low in the post LIBOR world. We covered this off in the Wrap on Thursday. The 5s/10s slope could potentially invert from here. Friday saw Westpac issue in the EUR market in both 5s and 10s, with lower basis levels helpful for the issuer. Today brings another Kangaroo in the market with a 10 year from Spanish borrower Telefonica. -MW

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