US
Improving sentiment tied to the Iran war is driving markets. Crude oil prices are trading on the defensive, US stock futures extended record highs, and long-term bond yields continue to retrace their recent overshoot. USD is a little lower against most major currencies.
In our view, the dollar index (DXY) can overshoot the upper end of its nearly one year 96.00-100.00 range in line with interest rate differentials between the US and other major economies. Moreover, US rate hike expectations are USD positive because they reflect a resilient US growth backdrop and sticky inflation. In contrast, ECB or BOE rate hike expectations are less supportive for EUR and GBP as they reflect a stagflationary mix of high inflation and weak growth.
The ECB May Financial Stability Review does not move the dial on rate expectations. The ECB warned that prolonged geopolitical tensions, along with growing concerns about the sustainability of public finances, increases the risks to financial stability. Additionally, liquidity and leverage vulnerabilities in the non-bank financial intermediation sector could amplify market stress.
NEW ZEALAND
NZD outperforms and NZD/USD rallied to an intra-day high near 0.5880. NZD/USD should continue to trade within a narrow 0.5800-0.6000 range in the near term. The stronger US growth outlook relative to New Zealand limits NZD/USD upside.
RBNZ delivered a hawkish hold. As was widely expected, the RBNZ left the Official Cash Rate (OCR) unchanged at 2.25% for a third straight meeting. However, the decision went down the wire in a 3-3 vote split. Governor Anna Breman, Karen Silk, Chief Economist Paul Conway voted for a hold. Carl Hansen, Hayley Gourley, Prasanna Gai voted for a 25bps hike. In this instance, the governor’s casting vote broke the deadlock in favor of staying on hold.
Moreover, the RBNZ updated OCR path adjusted higher closer to the pricing from the swaps curve (150bps of tightening over the next three years). A first full 25bps OCR hike is implied sooner in Q3 vs. Q1 2027 previously and a total of 100bps of tightening is penciled in by 2029 vs. 75bps previously.
AUSTRALIA
AUD/USD dropped to intra-day lows near 0.7136. We expect AUD/USD to stabilize lower around 0.7000, the level implied by Australia-US 2-year bond yield spreads.
Australia April inflation was mixed. Headline CPI dipped more than expected to 4.2% y/y (consensus 4.4%, March: 4.6%) while the trimmed mean CPI matched consensus at 3.4% vs. 3.3% in March. The monthly CPI is Australia’s primary measure of inflation, but the RBA continues to focus on measures of underlying inflation from the quarterly CPI. Australia Q2 CPI data is due end-July.
RBA cash rate futures trimmed bets of a 25bps hike by year end. In our view, the risk is skewed towards a more extended pause in the RBA tightening cycle. First, the RBA projects real GDP growth to be below potential over the next two years. Second, the RBA cash rate at 4.35% currently sits near the top of the range of model-based central estimates of the nominal neutral rate.
