FX

AUD - AUD/USD printed a new marginal high overnight (0.6688), but it was a bystander. EUR/USD broke out to new 4yr highs and USD/CHF fell to fresh near 12yr lows. USD selling momentum ahead of the Fed is obviously decisive and broad. A decent US Aug retail sales print and upward revisions to Q3 US GDP nowcasts did little to arrest the momentum.

The caution has to be that the bar for a dovish Fed surprise this evening is now elevated. We assume there will be at least 1 dovish dissent for a larger cut, with Miran a confirmed voter, and maybe even 2-3 dissents. There is a decent chance that another cut might be added to the median 2025 dots too. That would imply a series of cuts into year's end, validating pricing, and make the overall tone net dovish, even if Powell's press conference plays its neutral. But much of that is now priced in.

In the event that the Fed leap frogs dovish expectations and delivers a larger 50bp cut or signals a series of cuts AUD/USD likely trades deep into the 0.67-handle. On the flipside AUD likely relinquishes the 0.66-handle and could trade back to near the 0.6580 in the event of a hawkish surprise.

But we still think core AUD longs make sense regardless the outcome. AUD forward momentum has been more emphatic and satisfying lately and it isn't entirely down to the dovish repricing in Fed expectations.

AUD looks very clean vs G10 peers on the two big macro themes of the moment too. Idiosyncratic political & fiscal challenges periodically cap EUR, JPY & GBP prospects, while labour market/growth momentum concerns cap CAD, USD & NZD. AUD looks like a genuine safe harbour amid these stories. The Australian consumer has awakened from its slumber too. The RBA will probably take note that the full impact of May and August rate cuts have yet to wash through too, and they may be debating if policy is “still somewhat restrictive”. This puts a floor under RBA terminal rate pricing (around 3.1%), while terminal for peers like the Fed, the BoC & the RBNZ continue to edge lower. A decent jobs update this week will sustain this narrative, while a softer update will complicate the case for AUD outperformance.

China is admittedly a potential a source of angst for AUD - softer Aug activity data clearly show waning momentum. But Beijing seems more likely than not to step up stimulus efforts. China asset markets are certainly getting that message loud and clear. Reports that Beijing is planning to assist local govt's with USD1trn in arrears bills are encouraging. There is ample scope to speed up delivery of already budgeted fiscal spending too. Beijing remains more policy reactive than pro-active, but their intent is overall much more determined and forceful, and can continue to provide a reassuring floor on China prospects. We are still awaiting the 15th five-year plan and the 4th plenum late Oct. Credible plans to tackle chronic excess supply and boost consumption/services would be market positive.

Net, net, we target 0.6730 on a 1mth horizon and 0.6800 on a 3mth horizon. We are open minded about the potential for a bigger bullish breakout. The caution is that the 0.6800-0.6940 area has been very unstable and short-lived terrain in the last 2 ½ years, and there’s not a lot of untapped impetus left in Fed easing expectations (-120bp by mid-2026). There is admittedly some latent upside potential on the AUD-leg, say from a hawkish repricing in the RBA curve, if they do not cut in Nov, but that is not our central scenario. A bigger bullish breakout is more likely a 2026H1 event, when Fed independence risks crystalise more significantly, and when 12mth hedging horizons start to incorporate negative AUD-FX points, i.e. hedging upside is paid.- RF

NZD -NZD/USD has ground higher over the past month, from 0.5800 to 0.5991, and retains upward momentum. Absent a surprise from the FOMC we would probably see 0.6000 tested. But given US pricing, whether the FOMC outturn is market-dovish or market-hawkish seems an even bet. A few hours after the FOMC we’ll get NZ Q2 GDP data, for which the median estimate is -0.3%q/q (Westpac -0.4%) and 0.0%%y/y, likely reflecting a subdued economy. Yesterday’s softish CPI partials were, at the margin, negative for the NZD. This morning’s Westpac consumer confidence survey remained soft, while Q2 current account data was much better than expected (via revisions).

AUD/NZD has risen from 1.0650 to 1.1191 over the past five months. While there is scope for slightly further upside this week, to test 1.1200, the large rally has left it technically stretched and in need of a correction. The main driver has been the contrasting guidance from the RBA vs the RBNZ – the former measured, the latter more emphatic - but these are now mostly priced in. Thursday is shaping up to be a big day for the cross – in the wake of the FOMC we get NZ GDP data and then AU employment.-IS

Rates

US Rates – Yields have enjoyed a modest rally into the widely anticipated FOMC rate cut decision. Despite a stronger than expected retail sales number, treasuries maintained their downwards momentum, with the front-end leading curves to be steeper. While a rate cut is widely anticipated, most likely 25bps, there is a small potential for 50bps and beyond that the messaging that arises out of the dot plots. Of special interest to valuations across the term structure will be the median projections for Fed Funds, especially the longer term. The latter, which can in some ways be seen as a “neutral rate” rose through 2023 and 2024 and has settled at 3% in the last 3 updates. Should it revert to a lower level it would likely provide the freedom for long end yields to fall into a new, lower, trading range. Indeed, recent developments including the appointment of Stephen Miran and Trump’s attempts to oust Lisa Cook have not provided confidence to a more neutral tone being maintained in the meeting. However, we consider risks to this view if messaging in the meeting does not follow through with the expected dovish leaning messaging. Given the amount of easing already priced into the curve, a reversal in the other direction may see yields retreat to levels seen at the start of the month.

Outright: We have certainly been on the wrong side of recent price action, with the pace and size of the recent rally challenging our understanding of market drivers and our range expectations. That is, we have long nominated 4% as the range low for the 10yr yield, so we are tasked with backing that level and recommending shorts, or succumbing to the price action and the information contained within it. The case for fighting the trend is best summarised by the view that there is already too much policy easing in the current forward cash profile to reflect the medium term economic risks. The case for shifting term yields lower is predicated both on a more bearish outlook for the economy that necessitates accommodative policy, and an expectation that the Fed will lean dovishly, as well as a growing sense that the Administration will undertake extraordinary measures (YCC anyone?) to keep long end yields low despite the significant issuance profile ahead.

We have certainly cautioned that our more bearish medium term view would be a slow burn over time and, respecting price action, we have shifted to a neutral stance in recent weeks. That remains the case. Beyond the near term, however, we have not yet given up on our medium term view, that outside of a dramatic collapse in economic activity (despite significant fiscal stimulus), yields have little reason to fall significantly and numerous reasons to rise. But that is a discussion for another day.

Curve: The 2s10s and 5s30s curves have slightly re-steepened from the recent flattening trend since the start of September. Our base case remains for a consolidation of the 2s10s curve to levels above 50bps in coming weeks as Fed expectations are recalibrated. A lot of easing has already been priced into the front end, meanwhile the 10yr yield continues to explore range lows. We don’t expect a push to flatten past current levels in the long end of the curve, our bias remaining for steeper levels given supply considerations and nascent de-dollarisation trend.

10yr Spread to Bund: USTs continue to marginally outperform their European counterparts, with the spread making new lows each week. The current spread is the narrowest since the Trump’s tariff shenanigans began in early April and now at levels seen in Mid 2023. We expect US outperformance to slow as US bonds get more expensive within their expected outright range. – UC

AU Rates – The AU rates market has held on to positive price action led by offshore moves, particularly in the US. Front end pricing, however, remains little changed with the market holding on to a 10% probability of a September cut and 75% of a cut in November. Sentiment in the AU rates space has shifted in the opposite direction of the US since the stronger-than-expected 2Q GDP outcome. So, it is right for the market to question both the length of time that the RBA could remain on hold and the terminal rate calculus beyond that. Indeed, we question whether pricing for the November meeting would not reflect a lesser likelihood of an RBA rate cut if the US backdrop had not rapidly evolved in the other direction in recent weeks. We suspect that at some stage the November meeting will be pricing more a 50/50 proposition. Yesterday’s speech by RBA’s Sarah Hunter discussed that the central bank was close to achieving a “goldilocks” outcome of low inflation and full employment. The August labour market print this week will be closely watched given the RBA’s steady forecast of unemployment remaining at 4.3% for the foreseeable future.

Outright: After trading to new range lows in the immediate aftermath of the GDP data, both 3yr and 10yr bond futures have rebounded and are now back inside their old trading ranges (96.50-70 and 95.60-80 respectively). While the US directional impetus is the near term driver of that performance, in our view, given recent price action, we suspect the market will remain vulnerable to more hawkish outcomes in coming weeks. Indeed, as discussed above, if there is no follow through with dovish messaging from the FOMC meeting, a sell-off in the US rates market may provide near term directional influence to price action in AU.

Curve: The GDP added to the “cautious” messaging from the RBA and supported a slight flattening of the curve. It also supports the narrative that the domestic curve should maintain a smaller beta with global curve moves. Relative fiscal positions and hence issuance burdens support that. That is, the AU curve should flatten in an absolute sense and can continue to undergo a relative flattening to other markets.

Swap Spreads: EFPs have moved a little wider but remain within their well-trodden ranges. Even so, they have stayed inverse and consistently weathered well-above average corporate pay-side flows throughout 2025. So, should that slow, then there is scope for a resumption of narrowing impetus as large ACGB supply continues. For now, however, there are few catalysts to expect the spreads to remain within recent ranges.

Semi Spreads: The September/October period is often one in which ratings updates are provided and S&P kicked off the “season” with a downgrade of ACT from AA+ to AA. The question then becomes, which state is next? We think there is a significant risk that Tasmania will be next. It is currently on negative outlook, while the recent political impasse and ongoing travails of the minority government would not provide much solace when set against their spending and debt burden, which have been surging in recent years. Queensland will also be under the microscope, although our expectation would be that the new Government will be given more time to establish its financial management and budgetary performance credentials.

10yr Spread to UST: Outside of weight of money arguments, which will have a medium term narrowing influence, the relative monetary policy driver is unlikely to assist any near term performance. We are in the zone to re-enter narrowers and are at range wides seen during the Tariff impacted month of April, but perhaps need to get an idea of clear extremes before positions are either re-initiated or added to. –UC

NZ Rates - The downward trend in the NZ 2yr swap rate, which started in 2023, has extended to 2.81% today. Slightly softer CPI partials yesterday, and lower US rates overnight, encouraged pricing for November to inch towards a 2.50% terminal rate. The 2yr will be hostage to US rates overnight, and then to any NZ GDP surprise tomorrow. Surprises aside, there’s scope for the 2yr to test 2.80%.

The RBNZ in August forecast a 25bp cut at each of the next two meetings, taking the OCR to a cycle low of 2.50%. OIS prices imply a 90% chance of a rate cut at the next meeting in October, and an 80% chance at the November meeting.

The NZ yield curve’s flattening in early September has stalled, awaiting the FOMC and NZ GDP data. Last week we entered a NZ 2-10yr swap flattener at 97bp, targeting 50bp, based on an expectation that markets would start to price the next RBNZ tightening cycle within the next six months. The main risks to the trade are that the OCR needs to fall below 2.50% to revive the NZ economy, and US debt level concerns intensify.

NZGB swap spreads remain near the bottom of multi-month (and multi-year) ranges, the 2035 currently at -51bp. Global debt level concerns have spilled over to NZ, despite a backdrop of consolidation in NZ’s fiscal outlook (announced at the May Budget) and the approaching end to the RBNZ easing cycle. We will continue to watch for opportunities to enter a paid swap spread trade.

The NZGB-ACGB 2035 spread remains around the bottom of a 10-month old range and vulnerable to breaking lower. The NZ-AU 1y1y swap spread at -43bp is at an eight-month low, and could fall further if NZ GDP and AU employment data on Thursday continue to reflect contrasting economic strength.

Funding, basis, and liability management.

RBA OIS pricing is back to 20bp in Nov, as global yields have shifted decisively lower, and with that, expectations of rate cuts have shifted. While that has primarily been driven by the US market moves, Australian and NZ markets have followed the same path. The RBA terminal rate remains above 3%, sitting at 3.10% for June, having eased since mid-last week. The week ahead has multiple central bank meetings, including the FOMC where the market is fully priced, and of course will update views on their path ahead. With the market poised to deliver an expected 25bp, and almost no pushback on the risk of a larger move, rates have held their ground across STIR and tenor. This will hopefully provide clear guidance on what markets should be looking at and can influence the RBA views. Moreover, the labour force data is released this week, against a backdrop of a flatlined 4.3% unemployment rate over the forward estimates.

While term rates have also dropped, driven by moves in global markets, the target levels we held in Australian rates have not been achieved as yet, and the 1 year forward 3-year IRS is sitting just above 3.45% on a mid-market basis, so around 5bp on where we would find best value. But, given the big shift lower in US Treasury yields, with 4% a whisker away in the 10 year, we would see the opportunity for corporate hedgers to start to look at hedging strategies. A further benefit to consider is that in the directional move lower for rates, the curves have flattened, and that provides some ability to stretch tenor hedging a little further in spot or forward swap space.

Post the corporate reporting season, Australian corporates have been active in issuance, particularly in offshore markets. While some deals may not be swapped back to A$, others are, and there has been decent two-way flow in Xccy from both the Australian issuers heading offshore as well as the swathe of receive side flow (net larger than payside) coming from the Kangaroo issuers finding strong demand for A$ bonds. In recent weeks, the market saw some SSA issuance which at first appeared to have no impact on basis, but has seen a shift lower, and some of the longer tenor Xccy is at the lowest levels since the start of the year, when markets had moved in anticipation (and delivery) of the SSA supply. In last Tuesday’s Wrap we covered off on this a bit more and noted the seasonal bias to lower term Xccy basis in spot and forwards has seen the historical September move already achieved. We would also note that the 5y5y BBSW/SOFR rate is now at the lowest levels since late 2024, unsurprisingly given the focus on increased hedging from super funds. Last weeks’ US$550m NBN 5 year deal did nothing to form a base, and we’d point out that receive side flow has been almost 10 times that amount in recent weeks. Transurban was in the market overnight with US$650m long 10s. The ultra-long Xccy curve (10s/30s) is till near the recent lows but has a positive slope (just). There’s been no long end placements offshore for a few weeks, and this may have allowed clearing of positions. We still see a vulnerability for the curve to steepen on the private placement flows in 30 year tenors in EUR/USD/CHF.

FX/OIS is still taking its time to retreat from the elevated levels we have discussed over the last fortnight, but that is a broader theme across markets, whereby USD funding is cheaper and this is driving other markets to ‘look expensive’. We are less than a month away from the front break falling into the year-end ‘turn’ funding, so there should be little in this to drive markets. One factor to consider will be the 30 Sep FY end for three of the four major Australian banks. This typically sees a modest tightening in funding markets but can often be more noise than signal. BOB spreads have edged a touch higher but are contained. The A$ repo market is also seeing good levels of cash around and unlike the US into the quarter end has seen no lift in funding rates. This sits against a very active primary market (see discussions in recent end of day Wrap notes) which would see collateral lent to raise cash for participation in the new deals. -MW

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