• Shaky sentiment. Another rise in oil & long end bond yields dampened the mood. Equities a bit lower. NZD underperformed while AUD held up.
• Macro trends. ECB expected to hike tonight. US producer prices due. RBA rhetoric has been ‘hawkish’. Late-September RBA hike now ~75% priced in.
Global Trends
A few jitters have returned to markets with higher oil prices, on the back of the intensification of attacks on shipping and energy infrastructure in the Middle East, and another move up in bond yields dampening the mood. Brent crude has risen above US$101/brl to be at the top end of its multi-month range, ~26% north of its 1-year average, and ~42% from its early-July low. Hostilities show few signs of easing with President Trump noting that the war may end after the November midterm elections. The drawn-out conflict and disruptions to supply have seen markets incorporate a greater risk premium. The longer these higher prices last the greater the potential negative impacts on global economic activity. Higher oil/fuel costs act like a tax on consumer and business spending.
The jump in oil prices and inflation impulse boosted global rates. US yields also received a kick along after the US Treasury said it would buy back ~US$6bn in its expanded programme, from ~US$2bn previously, with the upsized operation disappointing markets which remained concerned about the growing US debt supply stemming from persistent budget deficits. The US 10yr (now ~4.84%) is up at levels last traded in 2023, with the US 30yr yield (now ~5.29%) around its highest since mid-2007. This sapped the mood in equities with the S&P500 (-0.5%) and tech-focused NASDAQ (-0.6%) slipping back. However, outside of underperformance in the NZD (now ~$0.5840) and a dip in USD/JPY (now ~153.54, ~4.3% below where it was at the start of the month), the other major currencies consolidated over the past 24hrs with EUR at ~$1.1635 and AUD near ~$0.7217.
Tonight, the European Central Bank meets (10:15pm AEST), with the press conference (10:45pm AEST) due after the release of US producer prices (10:30pm AEST). US CPI inflation is out tomorrow (Friday 10:30pm AEST). The ECB looks set to lift interest rates again, but this is fully factored into the curve, as is ~86bps of tightening by mid next year. We think there is a risk the ECB hikes but doesn’t provide strong forward guidance about future moves, which if realised, may disappoint markets assuming more ECB action is in the pipeline. We think this could see the EUR (the major USD alternative) lose a bit of ground in the short-run. At the same time signs of stronger US producer price inflation could bolster the case for a US Fed rate rise which might support the USD. Markets are assigning a ~64% chance the US Fed lifts interest rates next week, with ~1.5 hikes discounted by year-end, and ~3 moves factored in by late-2027.
Trans-Tasman Zone
The shaky risk sentiment generated by the rise in oil prices (brent crude is north of US$101/brl) and a further increase in bond yields hasn’t generated much movement across FX. Outside of USD/JPY, which dipped a bit further overnight, and the NZD (now ~$0.5840), which has struggled since the recent RBNZ ‘dovish’ rate hike, other currencies have been range bound. At ~$0.7217 the AUD is hovering near the upper end of the range occupied since mid-May and is less than ~1% from its early-May cyclical peak. On the crosses, the AUD tread water versus EUR, CAD, GBP, and CNH the past 24hrs, while the pullback in AUD/JPY (now ~110.80) extended, as has the upswing in AUD/NZD (now ~1.2358, levels last traded in early-2013).
There has been a tough talk from RBA officials this week with Assistant Governor Hunter and Deputy Governor Hauser expressing concern about too high inflation. In our mind, the rhetoric suggests the RBA staff may recommend to the Board that a hike is the best course of action at the 29 September meeting given upside inflation risks. That doesn’t automatically mean it will happen given there are 9 voting members on the Board and only 2 (Gov. Bullock and Dep. Gov. Hauser) are RBA officials. But as stated before, it looks to be a matter of when, not if, the RBA acts again as it tries to tackle inflation (i.e. if not in late-September (which is now ~75% priced in) then the meeting on 3 November (which has ~30bps of tightening discounted) would be probable).
In 2022/23 other central banks raised rates ~200-225bps above ‘neutral’, while the RBA actively chose to only move settings ~85-100bps into the ‘restrictive’ zone (which is where things are now at). Inflation isn’t as high as it was back then, so rates shouldn’t need to be raised as far. Tightening policy into the unfolding housing downturn is another factor that needs to be considered as it will mean the domestic economic environment could be even weaker than assumed.
For the AUD, short-term momentum seeking participants are drawn to the idea of another RBA hike. But as outlined previously, while a higher RBA cash rate/wider rate spreads translate to a higher average level for the AUD compared to the past few years it doesn’t mean there might be much more upside given the starting point, what is already factored into the rates curve, the looming hit to the local economy from rising mortgage costs, and outlook for other central banks to deliver more than the RBA from here. The AUD is also around ‘overbought’ levels on technical indicators, and our models indicate a lot is already baked in (‘fair value’ is estimated to be ~$0.7150).
