FX

AUD – The immediate liquidation pressures on JPY-crosses appears to have abated for the time being and key equity indices and commodities are tentatively stabilising. Wider ranges for AUD/USD though still seem likely this week. The gloomy China mood won't lift anytime soon, and June official China PMI likely underwhelm amid a broader loss of rebound momentum this week. There is a risk of an unwinding of RBA rate hike pricing if this week's Q2 trimmed mean CPI prints in line with WBC expectations (+0.9% q/q) too. Combined, that can see AUD test 0.6480 in the week ahead.

Our best guess is that from here AUD/USD transitions into more of a two-way range trading environment, similar to the Feb-Mar 0.6480-0.6630 range. AUD downside should ultimately be contained by what will be an increasingly dovish Fed (the 31 July FOMC, the 22-24 August Fed Jackson Hole symposium and 18 Sept FOMC), while upside will be contained by US election uncertainty, ongoing China growth doubts and a potential dovish repricing to RBA expectations. -RF

USD – Fed confidence around disinflation and guidance into the labour data next week will be key for USD direction as well as stock market sentiment for August (with the DNC convention on 19th and Jackson Hole on 22nd). DXY is holding above prior range support at 104.00 though may face selling pressure if the FOMC statement and Powell's press conference confirm that the balance of risks between its price stability and full employment objectives are about even. Powell might not explicitly promise a Sept rate cut, but he will likely hint at it.

EUR – While there are disconcerting signs of persistent pricing pressures within flash PMIs and the latest Indeed wage tracker, slowing activity signals likely prove more decisive for the ECB, leaving the Bank on track to cut in Sept. EUR/USD though likely a 1.08-1.09 trade for now, with downside countered by a likely dovish Fed hold and easing Trump election risk.

JPY – More vocal Japanese political support for a BoJ hike and relatively solid recent Japanese data continue to suggest a more active BoJ this week, including another +10bp policy hike and reduced JGB buying plans. Rebounds off the test of prior strong resistance and now support in the 151.75-00 area could even push towards 155.00, but this should now act as an upside hurdle. -RF&TR

NZD - NZD/USD retains near-term downward momentum, targeting the 0.5800-0.5850 area this week. The main factor has been a more risk-averse mood in markets, supporting the US dollar. Falling NZ-US yield spreads (some are now negative) are also weighing. There’s little major event risk from NZ this week, but from the US, the FOMC and US payrolls data will be influential. AUD/NZD continues to consolidate around 1.1100, needing a fresh catalyst to break out of its multi-week range. We retain a bullish multi-month outlook and will buy on any dip to 1.1000. The RBA/RBNZ contrast should remain evident for some time, and current and fiscal balances should remain in the AUD’s favour. Multi-month, 1.1400 is not implausible.– IS

Rates

US Rates: The PCE data on Friday did nothing to discourage the overwhelmingly positive UST sentiment as we head into Wednesday’s FOMC. Over the week, 2yr notes fell around 13bps and the yield curve bull steepened in anticipation of the Fed providing a green light for a rate cut in September. While we believe that is likely, given that that outcome is already fully factored-in and another two cuts in rapid succession beyond that, we are also questioning just how far the bond rally might extend beyond current levels. We suspect that the preferred maturities will be at the shorter end, which should continue the recent curve steepening theme.

Outright: 10yr yields are now back below 4.2% and set to retest the key technical support around 4.15% this week. The Fed should provide the catalyst for a push lower in yields, however we continue to expect longer yields to be relatively rangebound. Our tactical approach remains to be either long or square. Until the Fed beings its easing cycle, we continue to believe that it will be difficult for 10yr yields to push materially and sustainably through the 4.15% level, as reflected in recent price action.

Curve: We expect the steepening impulse to continue and for the 2s10s to move back into positive territory over the next week or so. The steepener has been a slowly accruing trend and should continue with support from the Fed and from the future fiscal situation.

10yr Spread to Bund: The recent underperformance versus Bunds reversed on the data, with the 10yr spread around 180bps. There is scope for a push back to 175bp on the FOMC, although we would not expect a major re-pricing of the spread on the outcome.

AU Rates: The market continues to await Wednesday’s CPI which is crucial to near term outcomes and the RBA policy debate. We continue to believe that there is a very high bar for the RBA to deliver a further hike, especially given the global policy backdrop and their dual mandate. Clearly any policy shift would come down to the level of inflation, the breakdown of its drivers and expectations around the pace of the disinflationary trend and the appropriate period for the underlying rate to move sustainably back into the band.

Outright: Directional impetus will continue to be determined by global price action ahead of the data. Before then we expect yields to respect the boundaries of recent trading ranges.

Curve: We expect the curve to be directional, led by the long end. It has followed the US curve steeper in recent weeks, although the extent to which it can steepen is limited by the residual RBA rate hike risks. and longer end support from global investors seeking yield. We believe the latter is a dominant influence.

Swap Spreads: EFPs have bounced off the new recent lows. From a macro perspective, the transition toward an easing cycle will likely keep receive-side flows as the dominant hand, although forward outright swap rates are getting to levels that might encourage some hedge-related payside at some stage. Our view overall is that swap spreads can trade with a narrowing bias, but also that the 10yr EFP will find it hard to sustain a single digit spread.

10yr Spread to UST: The AU-US 10yr spread remains in positive territory but has been narrowing over recent sessions. We think that price action is instructive and have now lowered our target for re-entering narrowing trades from +20bp to +15bps. The CPI will more than likely disappoint those with a hawkish RBA expectation and any removal of hikes from the forward cash profile will be supportive. - DM

NZD Rates- NZ swap rates fell further last week, continuing to respond to the RBNZ’s dovish signal at its MPR three weeks ago, as well as weaker economic data momentum. The moderate fall in offshore bond yields has also been influential.

Markets now price a 65% chance of a rate cut at the 14 August MPS (from 50% a week ago), while October remains fully priced, and three cuts are priced by November. Out economists forecast the first cut to be in November but acknowledge some chance of August or October.

The 2yr swap has fallen 100bp since early June, to 4.19% - the lowest level since September 2022. Given that performance, and the likelihood that most of the forthcoming easing cycle is already priced in, any further downside ahead of the labour data on 7 August is likely to be much slower than it has been.

Our NZ 2-10yr steepener vs AU 2-10yr flattener has performed well since February (-90bp to -34bp). We’d prefer to hold it until the NZ curve becomes positively sloped (currently -11bp) but are mindful of risks around AU CPI data this week.

NZGB i-spreads have risen further, the 2035 now at 34bp, not too far from the GFC and pandemic crises highs around 40bp. We continue to assess conditions with a view to buying NZGB vs swap. – IS

Funding Basis and Liability Management

Australian markets face a big week, talked up for months as the Q2 CPI drops and largely determines the path of monetary policy for Australia. While there are also big events taking place offshore in terms of central banks, the pulse check on inflation here is one that the August RBA meeting ostensibly hinges on.

The last few weeks have seen big moves in funding markets, with the FX/OIS basis elevated from tom/next to 3-month tenors, as the long shadow of the end of the FY and the TFF have impacted the markets. We have discussed this subject daily, and at length, but it is probably until the CPI passes us by, and we get to month end flows that the issues can now truly abate. We had certainly not expected such an elongated move, and would note higher ES balances, cash from bond maturities hitting the market last week and the potential for banks to use the arbitrage and lend into the higher rates, would all be reasons for the moves to be temporary.

BBSW rates and the forward implied yields, as well as BOB spreads have all jumped, but since Friday have started to drift lower. This has also been evident in the front end of the cross-currency basis market. The front break was marked at 10bp on Friday and has eased to 5bp today, but, if the market normalises, we expect to see it trade flat to 3bp. The longer tenors are higher, but 5y5y has stayed contained. Month-end flows later this week should add to downside pressure. 6s/3s basis, after dipping slightly, perked up. Our view is that this too will ease back 2-3bp and hold. Corporate paying and asset swap flow as the new month starts are the drivers of this view.

Last week we talked about the impact the sharp and decent sized drop in AUD has on Xccy collateral. The move is certainly not as significant as we have seen before, but a link to a note last year explains the subject.

https://www.westpaciq.com.au/markets/2023/08/spotlight_AUDFunding

In linear swaps, despite funding pressures, the trend for rates has been lower, witness the sharp moves in the UST 2 year note for example. Australian yields are off their highs, and back towards the lower end of recent ranges. Corporates looking to hedge have the advantage of the lower terms structure and the inversion in the forward curves, as well as the inversion of the floating vs fixed rate tenors.

Higher BBSW sets and the lower spot and forward swap levels now place the mid-market of 3-month BBSW into 3-year swap at -45bp, the most inverted levels since April. The house view remains for a moderate CPI that could lead to a November RBA rate cut. While that is out of consensus, everything appears to hinge on the data this week.– MW

Crude:
We are sticking to the view that Brent should remain in an $80 to $85 range until we have a better understanding of the supply demand balance through the third quarter. On the one hand, product demand remains weak with the focus on disappointing growth in China. We noted last week that MysteelOiChem was forecasting diesel demand to fall 5.6%yy in H2 following a 4.2% drop in H1 while overall product consumption could decline 3.8%yy in H2 according to China Petrochem. Meanwhile, China’s apparent oil demand fell 8% in June according to Bloomberg calculations. This chimes with the recent IEA monthly which reported that global oil demand growth slowed to its weakest in more than a year last quarter. However, on the other, increased OPEC+ compliance, the wildfires in Canada and a ramp up in global refinery activity has seen global crude inventory plunge to March lows in recent weeks suggesting that crude demand is solid and supply well managed. JP Morgan estimates that July 1-24 demand is 1.7mb higher than a year ago. Key for the week then will be the JMMC which meets Thursday though it’s not clear that any formal statement will be released.

Metals:

We have stuck to a strong bearish copper view for some time, arguing that we were headed down to the 200dma just below $9,000, with the focus very much on sharply rising global inventory, as China dumped unwanted copper into global markets. We still think copper has further to go here, however, SHFE copper inventory has fallen for the third week in a row now and that has been enough to drag our measure of global copper inventory back from fresh 51-month highs. Now whether that is enough to prevent a deeper correction through the 200dma remains to be seen. However, we just beginning to re-enter the upper end of the very broad $8,000 to $9,000 range seen for much of 2023, and with the market in deeply oversold territory, that may be enough to see a bit of range trading before we start to get the next wave of Chinese production and export data mid-August.

Iron ore:

We have been arguing for the last week or so that we were surprised that iron ore has not had a proper test sub $100. We did get a brief dip below that level mid last week, but we don’t view that as a proper test. We note that Chinese iron ore port inventory rose sharply again last week, with the largest percentage rise since mid-March suggesting supply remains ample. Inventory has risen in 25 of 29 weeks so far this year, hitting the highest level since April 2022. With billet, rebar and HRC prices way through the March/ April lows, we just don’t see a compelling argument for the lows being in for iron ore prices and still feel that a test down to $90 is coming. New rebar quality standards published by the State Administration for Market Regulation come into effect on September 25 so we suspect that we will see that break lower in the next month or so, as dealers look to clear rising current steel product inventory. -RR

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