FX

AUD – AUD/USD hovered around 0.6530 on Friday before news of Israel's attack on Iran saw the USD rally broadly with the pair plunging around 1%, bottoming out at 0.6457 in line with a notable risk-off move. A decline in US 1-yr inflation expectations to 5.1% from 6.4% saw the USD briefly pare back some gains, however AUD/USD finished the week below 0.65 following Iran's retaliation on Israel. The pair has since traded back up to 0.6480 and while heavily exposed to further Israel/Iran escalation, has remained resilient as the dwindling reliability of the USD and USTs as safe havens has provided a better backdrop for AUD.

Given Netanyahu's comments that the conflict could last for days, we see risks balanced on both sides. While AUD remains exposed to growing geopolitical tensions, the week ahead will feature a data flurry including the June FOMC, BOE and BOJ meetings. Markets broadly expect the Fed to remain on hold, however an update to FOMC projections present two-way risks for the USD. The Fed has long reinforced the upside risks to tariff-induced inflation, however with weak prints for April and May, it may be harder to substantiate the relatively more hawkish stance taken of late.

Domestic employment data for May is also due out this week with markets expecting a slight pullback in employment growth after April's surprisingly strong print, in line with a slowdown in net migration.

As such we remain neutral on AUD/USD for the week ahead and see merit for continued movement within a 0.64-0.66. Key levels on the downside continue to hold (0.6390/0.6410) and the bigger level at 0.6350/60 does not look seriously threatened. The USD has embarked on a sizeable decline against the majors after three years of swing trading within wide ranges, reflecting irrevocable damage from tariff chaos, policy reversals and a loss of policy credibility. In time it should land more evenly and broadly, including on AUD. -KB

Majors - DXY finished the week around 3-year lows below 98.0 despite a brief break upwards following news of the Israel/Iran escalation as a decline in US 1-year inflation expectations weighed on the dollar. Furthermore, with the FOMC rate decision due this week, we see two-way risks for the dollar as ongoing geopolitical conflict would likely see USD well supported. However given softer than expected prints for both April and May as well as ongoing tariff de-escalation, a downgrade to the FOMC's inflation projections could see the dollar slip below 98.0.

This in conjunction with the plethora of structural headwinds including an impending decision by the US Court of Appeals on the legality of Liberation Day tariffs, a deep breakdown in traditional correlations in response to the reduced reliability on US assets as safe havens and fiscal concerns will likely see DXY retest 97.50 over a 1-week period.

EUR/USD broke YTD highs at 1.1631 last Thursday, before conflict between Israel/Iran and a contraction in Eurozone Industrial output sent the pair hurtling back below 1.1550. While we expect EUR/USD to gradually resume this bullish uptrend, approaching 1.17 over a short-term horizon in line with the ECB's comments that they are nearing the end of their rate cutting cycle as well as easing US-China trade tensions, further Israel/Iran will remain a headwind for the pair. - KB

NZD - From last week’s bullish stance on NZD/USD, we shift to a neutral one this week given Friday’s attack by Israel on Iran. How this conflict develops during the week ahead will likely be a major determinant in the near term outlooks for most exchange rates. That said, so far the impact has been more moderate than we would have expected, possibly due to the US dollar’s tarnished safe-haven credentials. Absent a significant escalation, NZD/USD could find support in the 0.5900-0.5950 area. -IS

Rates

US Rates - Are USTs still a safe haven asset? Higher bond yields on Friday as the conflict in the Middle East escalated would suggest there is some downgrading of the market’s haven assessment, signalling a change of approach during “risk off” periods. But we should not overplay that thesis as the large rally in oil was an offsetting and, indeed dominant, factor driving pricing action on the day. Over the week, 10yr yields traded as low as 4.30% and as high as 4.5%, closing near the lower end of the range after a series of weaker data prints and some good auction demand. So we shouldn’t overplay a single narrative or read too much into a day’s price action. Indeed the prior week’s range was almost identical, albeit with a higher closing yield - a reminder that the broader market backdrop is characterised by a volatile range-trade and swift swings in sentiment and momentum.

The main question this week is whether the FOMC will materially affect valuations. The policy rate will remain unchanged, but there will be a keen focus on the “dot plot” and what Chair Powell chooses to emphasise in his press conference. He will certainly highlight the challenges in assessing risks to growth and inflation given the extreme uncertainties they are faced with. As such, we would not expect a material shift in the “wait and see” approach to policy, implying little change in the “dot plot” medians.

Outright: The market continues to factor-in a further two Fed cuts in the 2025 profile. We would not expect Powell’s comments to shift that materially, although we perceive a slight skew to market risks. That is, the market will be more responsive to a dovish tilt on the growth front, because, despite the surge in oil, the risks to inflation have not yet become a clear theme in data outcomes.

At the long end, we have consistently defined the medium term 10yr yield range as 4.00- 4.75% but also noted that we favoured a move to the upper range bound over time. The latter bias is now being challenged and will again this week if our market risk assessment is correct. But timeframes and trading horizons matter and we continue to hold our view given the broader context of the trade war, Trump’s massive fiscal spend and the nascent de-dollarisation trend. Even so, yields are not low enough within the range to encourage tactical selling and as such we are neutral at current levels.

Curve: Curve steepeners remain a strongly held view, which always triggers caution amid risks of a squeeze. However there is little reason to expect the curve to sustainably flatten from current levels and so we continue to recommend fading any material flattening. Over the medium term we expect the 2-10yr curve to eventually move back toward the 65-75bp level.

10yr Spread to Bund: The spread to Bund remains relatively stable, sitting just below the 200bp level. A move above that level would put the spread back into the pre-liberation day, and German large-scale debt package announcement, levels. The question is, whether that would appropriately reflect the new risk rewards for German bonds or whether relative fiscal policies and a shift in perceptions around USTs favours Bunds over USTs. We think it would and hence continue to believe a breach of 200bp and a move toward 220bp is possible over coming weeks.- DM

AU Rates – This week’s Labour Report looms as very important to the market’s assessment of the near term RBA risks. Should there be a clear deterioration in conditions, such as a decline in employment and a jump in the unemployment rate, then those looking for a July rate cut will be emboldened. On the other hand, an outcome that reflects ongoing strength in the labour market would go far to ruling out a July rate cut, triggering a major re-pricing. So there is a lot riding on the data from a near term risk reward perspective. Beyond the near term pricing considerations, however, Westpac has added two more rate cuts to our policy expectation. We expect the RBA to maintain its quarterly pace of cuts, with four more in total, taking the terminal rate to 2.85%, which is near the neutral rate.

Outright: Our new RBA forecast is largely in line with market pricing, So, there is little in it to shift the bond market from current levels, although it will add support to a tactical dip buying approach.

3 year bond futures remain within their 2-month range of 96.30 – 96.75 having twice failed to push above the range highs, while ,10yr futures have slipped 13 ticks from last Friday’s highest prices. We remain sellers into strength at the long end and buyers of dips at the short end.

Curve: While a well-held view, we continue to expect the curve to push steeper over the medium term. While a strong labour report would see the curve flatten, given that we think the forward cash pricing is largely appropriate, we suspect that medium term curve moves will be long-end directional. An even stronger view is that we expect the AU curve to flatten versus the US.

Swap Spreads: The futures roll is clouding some of the moves in EFPs, but in essence, spreads have moved back to their widest levels in some time. We will likely see those levels defended. In the medium term, we remain of the view of a heightened supply story in the domestic market dampening EFP levels. We see a level of -7bp in the June EFP as a level to be received given that weekly tender amounts will lift significantly in July. The main risk to this view is a large shift in global bond investor allocation to the local market, perhaps reflecting our attractive reward-for-risk characteristics, although that will be spread out over time and will not be a major driver of day-to-day spread performance.

Semi Spreads: It's Western Australia’s turn to provide a budget update this week, ahead of next week’s long-awaited QLD and NSW budgets. We maintain a range trading approach to the sector. While concerns around the fiscal impulse and hence ongoing supply will limit spread narrowing, equally important is the relatively high yields offered and the consistent buying on dips. Overall, we remain relatively positive on the sector. New demand cohorts attracted by high yields and wide spreads as well as the strong credit credentials of the states, will remain good buyers on dips, while RV versus SSA’s at the longer maturities is also a clear positive.

10yr Spread to UST: AU bonds continue to perform strongly on a relative basis, with the spread now around -18bps and periodic underperformance being short-lived. We expect it to remain in negative territory on average and continue to recommend fading any material widening. -DM

SSAs: A$ SSA spreads to bond slightly widened over Friday’s session following news of geopolitical turmoil in the middle east. This comes after a week of SSA spread performance in Euros and USD inspire of a period of strong issuance. In Europe, the Council of Europe Development Bank (CEB) took advantage of the heightened week of issuance and priced a €3.5bn 10 year deal on Thursday. There was a flurry of issuance from Canadian issuers last week, with Export Development Bank (EDC) returning to the dollar market with a US$2bn 5 year deal which priced 4bps through the initial guidance range. Names such as KFW and ADB have had strong performance in dollars over recent weeks and we have recently noted that some have even traded through UST lines. It is a busy week on the central bank calendar with the FOMC alongside SNB, Norges and Riksbank also meeting this week. This may create a more risk-off tone for issuance activity, alongside the risk of an escalation of geopolitical tensions in the Middle East limiting spread activity. From a relative value front, the US curve swapped to AUD from SSA majors have edged higher and are in line with AUD and Euro lines. - UC

NZ Rates - The NZ 2yr swap rate retains a glimmer of upward momentum, but is likely to remain in a 3.15%-3.35% range during the week ahead. The RBNZ MPS in May was less dovish than expected, but recent NZ economic data momentum has slowed. NZ GDP data for Q4 on Thursday is expected to rise by 0.7%q/q. Market pricing for the RBNZ OCR implies only a 25% chance of a rate cut at the next meeting on 9 July, but one more cut in this easing cycle (by November 2025). NZ yield curves are unlikely to steepen beyond the cycle peaks seen in April. Over the next few months, the 2-10yr swap curve could flatten back into the 60bp-80bp range which prevailed in Q1. We favour buying NZGBs vs swaps on spikes in i-spreads, e.g. 2034 above 50bp. NZ’s fiscal outlook has not deteriorated any further, in contrast to some G10 jurisdictions, and this should attract international investors. -IS

Funding, basis, and liability management.

Westpac’s RBA forecasts changed at the end of last week, with the addition of two policy cuts in the first half of 2026. The 2025 outlook is unchanged, those being August and November rate cuts. Market pricing reflects the revised view, so it is unlikely to materially shift the dial for the terminal rate expectations.

In the forward swap curve, the 1-year forward 3-year swap is back under 3.25% on the most recent rally, but it is interesting how aggressively the market is pricing Australia. The labour force data this week is not expected to move too far away from the recent levels, but it will be important to change or keep perceptions of a rate cut in July. Of course, the global backdrop with tariffs and uncertainty on trade, as well as the conflagration of issues in the Middle East will be impactful for policy. In fixed rates, the AU 2s/5s has flattened since mid-week, having been on a steepening bias. This will play out as an advantage to hedgers who seek to add cover ahead of the 30 June FY end.

BBSW/SOFR markets continued to be better offered and the front break is firmly negative and FX/OIS basis also easing from the modest pop higher at the back end of last week. The shift lower is a reversal of what we saw from late April to early June, and to repeat, our hypothesis was that super funds lifted hedges and carry/leveraged funds unwound their trades. With the bounce in global equities and a move towards larger anti USD hedging, we thought the basis would ease. It took a while but is firmly there. There are plenty of flows across the board in Xccy, as both Australian names access offshore markets before the northern summer and Kangaroo issuers come to market. This week has been one of the busier ones. The term basis curve has not been as impacted, so deals can still come to market and are not being priced out.

FX/OIS basis has edged a little higher in the 1 to 3 month tenors but still sits at fairly low levels. The 6-month forward implied AUD rate is just over 3.5%.

On EFPs, the futures rolls will see a decent move in 10s of 4bp. The equivalent of Jun EFP at -7bp would be a good starting point to be received EFP for the supply story down the track. The AOFM’s borrowing task will increase as of 1 July, so that should at the margin weigh on bonds vs swap/futures. We covered this opinion off in the Wraps on Wednesday and Thursday.

Discussions in the market to be paid EFP, on the basis that Australian super funds would need to buy more ACGBs/Semis and thus drive EFPs higher as bonds richen, miss the mark in our view. Super funds are more likely to park their cash in bank paper or credit than to buy ACGBs/Semis. Even if they did, the flow would be modest and is unlikely to drive/offset swap spreads, particularly given the aforementioned issuance dynamics. -MW

Commodities

Crude:
Brent tested up towards Friday’s high at $78.50 this morning in Asia on weekend news that Iran and Israel had attacked each other’s energy infrastructure. We would highlight that these are focused on domestic production and supply. Yes, the attack on the massive Pars gas field is a very real concern. However, Iran consumes about 95% of the gas it produces. With no signs over the weekend of attempts to close the Strait of Hormuz, this morning’s move looks like an over-reaction to us.

However, Reuters reported that Trump had vetoed an Israeli plan to kill Iran’s Supreme Leader. Over the weekend, Netanyahu openly talked of regime change. And there have been reports of an ‘earthquake’ near the Fordow nuclear enrichment plant that is buried half a kilometre below a mountain. This emphasises how far Israel appears willing to go in this conflict, emphasising the geopolitical risks traders will have to face through the coming week.

Now, news that the situation was rapidly deteriorating was known well in advance. The US authorised dependents of service members to leave the region on Tuesday. Market positioning rapidly evolved through the week. Measures of speculative and managed money as of Tuesday jumped to the highest since early April, and likely jumped further before the attacks took place while option skews surged, suggesting the market had already begun paying up to protect topside risks well before the events of Friday morning.
Thus, unless we see signs of attacks on Iran’s export infrastructure or moves by Iran to close the Strait of Hormuz (noting some 26% of the world’s oil travels through the narrow water mouth) or Iranian proxies targeting shipping in the Straits, we don’t expect to see another near-term significant leg higher in Brent above the $78/80 region.
Bigger picture, we remain of the view that as we move into Q3 and global production rises and demand wanes, driving inventory sharply higher, we will see prices probing the lower end of the summer $60-65 range for Brent.

Metals:
We stick to the view that aluminium can both benefit from increasing signs of tightness in physical markets. Our measure of global aluminium inventory hit the lowest on record Friday, below levels seen in 2022 as the world was gripped by panic surrounding the Russian invasion of Ukraine and the potential for Russian metals to be shunned by global consumers. The July Shanghai aluminium contract has hit a 2m high and backwardation at the front of the Shanghai curve is rising sharply. We expect the move above $2,500 on LME aluminium will continue, though developments in the Middle East will cap near term.

Copper will remain capped at $9,800 near term, though the risks of a retest above $10,000 for copper are out there. We still want to sell copper once we know what the section 232 tariff is.

Gold:

We are slightly surprised that gold hasn’t been able to move further above $3,400 given developments in Iran. ETF demand was somewhat muted Friday. However, with Trump’s willingness to let the two sides “fight it out”, it appears just a matter of time before we see fresh record highs.

Iron Ore:
We stick to the same views on iron ore. We are beginning to push further below the key $95 support level on both the SGX futures and 62% index. This is a move we have been expecting for some time now. We remain of the view that it’s only a matter of time before iron ore prices fall below $90 and beyond. China will announce industrial production for May later today, including steel production which came in well below expectations in April. If we see another weak print, that will add to the markets’ view that steel production is indeed being heavily curtailed by the authorities, adding to downside risks. - RR

Markets

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