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Overnight Market Wrap

Global market sentiment: Global PMI data disappointed, weighing on sentiment. The S&P500 closed down 0.9% and bond yields fell. Currencies were mixed.

Currencies: The US dollar index closed down 0.2% on the day, outperformed by safe havens yen and Swiss franc. EUR fluctuated between 1.0130 and 1.0255. USD/JPY fell from 137.96 to 135.57, the yen outperforming. AUD roundtripped from 0 6910 to 0.6977 and back. NZD roundtripped from 0.6240 to 0.6304 and back. AUD/NZD fell from 1.1111 to 1.1058.

Interest rates: US 2yr treasury yields fell from 3.14% to 2.97%, while the 10yr yield fell from 2.90% to 2.75%. Markets currently price the Fed funds rate to be 75bp higher at the next meeting on 27 July, and 180bp higher by year end.

Australian 3yr government bond yields (futures) fell from 3.25% to 3.10%, while the 10yr yield fell from 3.48% to 3.33%. Markets currently price the RBA cash rate to be 55bp higher at the next meeting in August, and 210bp higher by year end.

Commodities: Brent crude oil fell 3.3% to $103, copper rose 1.8%, gold rose 0.5%, and iron ore rose 4.8% to $100.

Event Wrap

US PMIs (S&P) were disappointing. Manufacturing fell to 52.3 (est. 52.0, prior 52.7), services to 47.0 (est. 52.7, prior 52.7), and composite to 47.5 (est. 52.4, prior 52.3) – lowest since May 2020. Most components recorded declines.

Eurozone PMIs (S&P) were also disappointing. Manufacturing fell to 49.6 (est. 51.0, prior 52.1), services to 50.6 (est. 52.0, prior 53.0), and composite to 49.4 (est. 51.0, prior 52.0). German PMIs were notably weak.

Event Outlook

Ger: Concerns around energy security and recession will be highlighted in the July IFO business climate survey (market f/c: 90.5).

US: Both the June Chicago Fed activity index and July Dallas Fed index should continue to indicate a weakening of business conditions in the US (Dallas Fed market f/c: -22.0).

Market Outlook

AUD/USD 1 day: The 0.7000 area may provide some resistance.

AUD/USD 1-3 month: The economic ripples from Russia’s invasion of Ukraine continue to underpin energy prices, strengthening the outlook for Australia’s already large trade surpluses. But the Aussie remains at risk against a US dollar backed by the Fed’s determination to frontload rate hikes and shrink its balance sheet, a notably more aggressive tightening stance than the RBA (at least for now). Daily correlations with equity markets are elevated even by the Aussie’s historical standards, so any renewed equity turbulence could see a return to trade with the 0.68 handle (along with occasional squeezes higher). Recovery to 0.74 in Q3 remains likely. Australian growth should be swift in Q2 and Q3, supporting pricing for RBA tightening, while China’s policy focus will once again turn to infrastructure-led growth. And at some point, USD yield support will reach the cyclical peak. (14 June)

NZD/USD 1 day: The 0.6330 area may provide some resistance.

NZD/USD 1-3 month: Potential for further weakness during the month ahead, 0.6200 likely to be tested. If that broke, we’d then target the 0.6000 area, which was an area of much congestion in early 2020. The main drivers of NZD/USD at present are global risk sentiment (proxied by equity prices, for example) and the US dollar (in turn driven by both risk sentiment and yield spreads). During the month ahead, the direction of risk sentiment will be key. But much further ahead, by year end, assuming sentiment stabilises, there is potential for the NZD to rebound towards 0.68. By then, the Fed story should be fully priced, which means yield spreads will no longer weigh on NZD/USD, while the spotlight will increasingly be on higher NZ commodity prices. (29 June)

AUD/NZD 1 day: Remains contained inside the 1.0950-1.1100 multi-week range.

AUD/NZD 1-3 month: The rally this year has been persistent with shallow pullbacks. There is potential for an extension towards 1.1400 during the next few months, being model fair value at present. The global commodities rally and Australia’s superior current account balance is expected to remain a major source of support for the cross this year. (5 May)

AU swap yields 1 day: The 3yr swap rate should open around 3.41%, the 10yr at 3.77%.

AU swap yields 1-3 month: The RBA has delivered 75bp of hikes and is likely to move the cash rate rapidly to 2.35% by Feb 2023, which we see as the terminal rate. While we believe that the market has too much factored-in for the RBA's terminal rate, that is unlikely to change given the RBA messaging. So, the bias is still toward higher rates over the next few months, supported by a hawkish Fed and higher energy prices. We expect 3yr swap rates to go as high as 3.75% over coming weeks. (10 June)

NZ swap yields 1 day: NZ 2yr swap rates should open down 5bp at 4.03%, while the 10yr should open down 6bp at 3.84%, in response to global (particularly US and AU) interest rate movements.

NZ swap yields 1-3 month: The updated message from the RBNZ in May, that the OCR could reach 4.0% next year, will keep a floor under short-end rates. However, the previously exuberant market pricing appears to have run its course, such that we’d expect 2yr swap rate to settle in the low 4s. The yield curve could still flatten further if recession risks and/or eventual easing are priced in. (30 June)

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